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    Audit Partner Tenure and Cost of Equity Capital
    research summary posted May 28, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.02 Changes in Audit Standards, 05.0 Audit Team Composition, 05.03 Partner Rotation 
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    Title:
    Audit Partner Tenure and Cost of Equity Capital
    Practical Implications:

    Prior research suggests that the length of auditor-client relationship affects audit quality, and, therefore, the integrity and information risk associated with a clients’ financial reporting. This study attempts to examine the effects of audit engagement partner tenure and rotation on investors’ perceptions. The results of this study raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner’s identity or pay attention to audit partner tenure. If investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure.  

    Citation:

    Azizkhani, M., G. S. Monroe, and G. Shailer. 2013. Audit Partner Tenure and Cost of Equity Capital. Auditing 32 (1).

    Keywords:
    audit partner rotation; audit partner tenure; cost of capital; financial reporting credibility
    Purpose of the Study:

    Recent proposals by the PCAOB suggest that audit firms should be required to identify the name of the engagement partner in the audit report. The proposals suggest that this provides useful information to investors by allowing investors to identify audit partner tenure and rotation. Professional accounting bodies and regulators have long been concerned that long auditor-client relationships impair audit quality. The PCAOB, however, has noted that other commenters do not believe disclosure of partner identity will provide meaningful information to investors. This study investigates the usefulness of disclosing partner identity by exploring whether audit partner tenure and partner rotation are informative to investors, as indicated by the ex ante cost of equity capital.

    Design/Method/ Approach:

    The authors tested the relationship between client-specific ex ante cost of equity capital and audit partner tenure using two models. The client-specific ex ante cost of equity capital was estimated using the price-earnings ratio divided by the short-term earnings growth rate. Auditor tenure was tested using raw, long transform, and quadratic terms. The authors also used two-stage regressions to address the potential for Big 4 selection bias. The sample was selected for all Australian-domiciled companies listed on the Australian Stock Exchange during the 1995-2005 time period. 

    Findings:
    • Partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements.
    • Imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor.
    • Partner rotation is associated with increased ex ante cost of equity capital.  
    Category:
    Audit Team Composition, Standard Setting
    Sub-category:
    Changes in Audit Standards, Partner Rotation
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