Auditor Tenure and Audit Reporting Failures

TLDR

The SEC has called for research on the link between audit tenure and audit failures. The study examines audit reports of companies that entered bankruptcy between 1996 and 1998 to investigate the relationship between audit tenure and audit failures. The authors conduct a multivariate analysis of audit opinions issued before bankruptcy and auditor tenure. Results show that audit reporting failures are higher in the early years of the auditor‑client relationship and that longer tenure is associated with fewer failures, contradicting mandatory rotation proposals.

Abstract

Recently, the SEC has called for research regarding the relationship between audit tenure and audit failures. In this study, we address this issue by examining prior audit reports for a sample of companies entering into bankruptcy during the period 1996–1998. We use a multivariate analysis to test for the association between the type of audit opinion issued on the financial statements immediately prior to bankruptcy and the length of auditor tenure. Our results indicate that there were significantly more audit reporting failures in the earlier years of the auditor/client relationship than when auditors had served these clients for longer tenures. The results do not support the arguments of those who propose mandatory auditor rotation and suggest that, contrary to the concerns expressed by the SEC, there is an inverse relationship between auditor tenure and audit reporting failures.