March 11, 2021

In the auditing world, there are two longstanding concerns that regulators, researchers and the entire auditing profession have debated for decades: social bonding (becoming personally friendly and overly trusting with the client), and economic bonding (being financially dependent on a specific client).

Recent actions from the European Union in 2014 and the financial crisis of 2008 have reignited these concerns, and research co-authored by Monika Causholli, Associate Professor of Accounting, seeks to shed some light on this debate by answering the question: does audit quality decline when firm tenure becomes long, or fees from auditor-provided non-audit services become large?

First-year audits are more likely to receive a lower assessment of audit quality, but audit quality improves significantly thereafter.

The study, titled: “Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality,” examined the data from an international audit firm’s review of audit process quality in 265 U.S. audits of both publicly and privately held clients.

“First-year audits are more likely to receive a lower assessment of audit quality, but audit quality improves significantly thereafter,” writes Causholli (with co-authors Timothy B. Bell of the University of North Florida, and W. Robert Knechel of the University of Florida). “However, we also find evidence of a decline in audit quality when tenure is very long.”

According to the research, the decline of audit quality in long-tenured clients is specifically attributable to private clients. In public-client audits, quality slowly increases over the entire tenure and is not significantly higher than in a first-year audit until tenure exceeds 13 years. In contrast, quality in private-client audits improves quickly after year one but declines with very long tenure to the point where it is indistinguishable from audit quality in the first year.

As for non-audit services (NAS), data showed that the public- and private-client samples once again exhibited different results. The association of audit quality with non-audit fees is positive in audits of public clients and negative in the audits of private clients.

“We find some evidence that NAS are positively associated with audit quality for SEC registrants, while conversely we observe a decline in audit quality for privately held clients as fees from NAS increase,” explain the authors. “Audit effort is not higher for audits where NAS is present but the audit fee and fee per hour are lower as a function of NAS.”

Overall, in first-year audits, lower audit process quality and higher total audit hours are possible additional costs that should be considered in the ongoing debate on mandatory audit firm rotation. Moreover, study results are consistent with the notion that—even prior to the effective date of the Sarbanes-Oxley Act (SOX)—market and related regulatory forces disciplined auditors of public entities to achieve a high level of audit quality when tenure was long or fees from auditor-provided non-audit services were large. In order to serve the public interest, these considerations should be included in assessments of the economic costs and benefits of restrictions on audit firm tenure and non-audit services. For the private-client market, the results suggest that audit process quality declines in the long tenure range and when non-audit fees become large. 

So, perhaps you should be asking yourself: have you kept your auditor too long?

Read more: "Audit Firm Tenure, Non-Audit Services, and Internal Assessments of Audit Quality" Journal of Accounting Research, Vol. 53, No. 3
"Audit Firm Tenure, Bank Complexity, and Financial Reporting Quality" Contemporary Accounting Research, forthcoming