Audit Firm Tenure, Bank Complexity, and Financial Reporting Quality

Research output: Contribution to journalArticlepeer-review

24 Scopus citations

Abstract

Theory from organizations and economics research posits that in an inter-organizational relationship, both parties invest in relationship-specific knowledge, which in turn facilitates the effectiveness of the relationship while strengthening the attachment between the parties. In complex settings where there are more opportunities for knowledge creation, the investments will be larger and the attachment stronger. Because banks are complex institutions that present unique challenges to auditors, we suggest that effective audits critically depend on the accumulation of significant investments in client-specific expertise through a long association with the client. We find a positive association between audit firm tenure and financial reporting quality, and this association is particularly strong in banks that are more complex. Also, contrary to recent research we find that benefits of audit firm tenure for complex banks accrue even for long tenure and are not limited to medium tenure. Our findings largely support the notion that a long relationship with the client reflects the underlying demand for expertise, which is critical for high-quality audits of complex organizations. Imposing short-term limits on audit firms would adversely affect the investments in client-specific expertise especially in the cases where this expertise is needed the most. Our findings do not support calls for mandatory audit firm rotation for large complex institutions.

Original languageEnglish
Pages (from-to)295-325
Number of pages31
JournalContemporary Accounting Research
Volume36
Issue number1
DOIs
StatePublished - Mar 1 2019

Bibliographical note

Funding Information:
* Accepted by Sarah McVay. We are grateful to Sarah McVay, two anonymous reviewers, Herman Van Brenk, Mathijs Van Peteghem, Marjorie Shelley, participants at the 2015 International Symposium of Audit Research (ISAR), 2015 Audit Mid-Year Meeting in Miami, 2015 Boston Accounting Research Colloquium at Boston College, 2017 International Conference on Assurance and Governance at the University of Florida, Nyenrode Business University, and University of South Florida for providing helpful comments. We thank Philip Chung, Meng Huang, Chris Pearson, Valbona Sulcaj, and Chong Wang for research assistance. Brian Bratten and Monika Causholli gratefully acknowledge financial support from the Von Allmen School of Accountancy at the University of Kentucky. Thomas Omer gratefully acknowledges the financial support of the Delmar Lienemann Sr. Chair of Accounting at the University of Nebraska–Lincoln. † Corresponding author.

Publisher Copyright:
© CAAA

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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