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    The Association between Audit-Firm Tenure and Audit Fees...
    research summary posted April 16, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.04 Predecessor Auditor Factors 
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    Title:
    The Association between Audit-Firm Tenure and Audit Fees Paid to Successor Auditors: Evidence from Arthur Andersen
    Practical Implications:

    The results from this study are important for regulators when considering mandatory audit firm rotation. The evidence suggests that auditors are concerned about the length of their new client’s relationship with their former auditor and perceive this as a risk factor in pricing their engagements. 

    However, the authors caution that the evidence does not necessarily support mandatory rotation. As Andersen was a high-profile case, it is possible that the fee premium observed in this study is unique to Andersen clients. Moreover, in examining mandatory rotation, the authors suggest that switching costs should also be considered in conjunction with the fee premium.

    Citation:

    Kealey, B. T., H. Y. Lee, and M. T. Stein. 2007. The Association between Audit-Firm Tenure and Audit Fees Paid to Successor Auditors: Evidence from Arthur Andersen.  Auditing: A Journal of Practice and Theory 26 (2): 95-116.

    Keywords:
    Auditor tenure, Arthur Andersen, audit fees, audit risk, auditor selection and auditor change, client acceptance and continuance.
    Purpose of the Study:

    There has been a long-standing debate on the effect of auditor tenure on audit quality and whether mandatory auditor rotation should be imposed on audit firms. Opponents of mandatory rotation, including the accounting industry, have argued that longer auditor tenure leads to more institutional knowledge being possessed by the auditor about their clients. This in turn helps increase audit effectiveness and audit quality. Proponents of mandatory rotation contend that it will lead to increases in actual and perceived independence and audit quality. 

    Recently, the Sarbanes-Oxley Act of 2002 set the mandatory tenure limits on engagement and review partners. While Congress was also interested in limiting audit firm tenure, they have not imposed such a requirement, but instead have issued a request for additional research on the impact of auditor tenure on independence. This study addresses Congress’ concern on the effect of tenure on auditor independence by examining whether successor auditors view their clients’ tenure with the predecessor auditor as a risk factor and whether they price this perceived lack of independence.

    Design/Method/ Approach:

    The authors use data on publicly-traded companies which were audited by Arthur Andersen in 2001, but who switched to another auditor in 2002. They examine the association between client tenure with Andersen and audit fees charged by the successor auditor.

    Findings:

    The authors document that newly hired auditors charge higher audit fees when the length of the client’s tenure with Arthur Andersen was higher. This suggests that new auditors perceive increased tenure with a predecessor auditor as riskier.

    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit fee decisions, Predecessor Auditor Factors
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