Auditor Tenure and Perceptions of Audit Quality

TLDR

The study examines how investors and information intermediaries perceive auditor tenure. The authors use earnings response coefficients from returns‑earnings regressions as a proxy for investor perceptions of earnings quality to assess the relationship with auditor tenure. Longer auditor tenure is linked to higher perceived earnings quality, a greater impact of reported earnings on stock rankings, and stronger influence of past earnings on one‑year‑ahead forecasts, supporting the view that tenure improves audit quality, yet mandatory tenure limits could impose unintended market costs.

Abstract

We analyze how investors and information intermediaries perceive auditor tenure. Using earnings response coefficients from returns-earnings regressions as a proxy for investor perceptions of earnings quality, we document a positive association between investor perceptions of earnings quality and tenure. Further, we find that the influence of reported earnings on stock rankings becomes larger with extended tenure, although the association between debt ratings and reported earnings does not vary with tenure. Finally, we find that the influence of past earnings on one-year-ahead earnings forecasts becomes greater as tenure increases. In general, our results are consistent with the hypothesis that investors and information intermediaries perceive auditor tenure as improving audit quality. One implication of our study is that imposing mandatory limits on the duration of the auditor-client relationship might impose unintended costs on capital market participants.