Volume 9 Issue 1 - May 27, 2009
Audit Partner Tenure, Audit Firm Tenure, and Discretionary Accruals: Does Long Auditor Tenure Impair Earnings Quality?
Chih-Ying Chen 1, Chan-Jane Lin 2, Yu-Chen Lin 3,*

1School of Accountancy, Singapore Management University
2Department of Accounting College of Management National Taiwan University
3Department of Accountancy and Graduate Institute of Finance & Banking, National Cheng Kung University

Contemporary Accounting Research, Vol. 25, No. 2, 415-445, 2008

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Recent accounting scandals all around the world have raised the challenge about auditor independence. The U. S. congress pass the Sarbanes-Oxley Act in 2002, and require the period of auditor partner rotation at lease once every five years instead of seven years. The United Kingdom changed the requirement as well in 2003. Netherlands, Germany, and Japan adopt similar requirement about partner rotation after 2003. Mandatory partner rotation started from 2003 in Taiwan. The main argument is that as the partner/firm tenure increases the earnings/ audit quality might be impaired. The reason is that auditors are too familiar with the client or auditors suffer the pressure to keep the client. Therefore, most of the authorities require mandatory partner rotation or discuss about mandatory firm rotation.

Most of the prior researches have not found that earnings/audit quality deteriorates with audit firm tenure. The argument might be longer firm tenure let the auditor can know the clients more detail and hence increase the audit efficiency, effect, and earnings/audit quality. We find only a little studies focus on the topics about the association between auditor partner tenure and earnings/audit quality because of they do not have the public data about auditors’ name. The regulations in Taiwan require that audit reports for public companies be certified by two audit partners and auditors’ names be disclosed in the audit report. Therefore, by analyze the public disclosed audit reports in Taiwan, we can investigate whether the audit partner tenure and audit firm tenure have any relation with the earning/audit quality. We can also investigate whether audit partner tenure or firm tenure has stronger effect on earning/audit quality. Main issues of this study are (a) whether earnings quality changes with audit partner tenure and (b) whether earnings quality changes with audit firm tenure after controlling for partner tenure.

This study develops two hypotheses as follows:
Hypothesis1.Earnings quality does not change with audit partner tenure.
Hypothesis2.Earnings quality does not change with audit firm tenure after controlling for parner tenure

Performance matched discretionary Accruals (DiscAccr) is used to proxy the earnings quality. We control the other relevant variables in equation (1) to test the hypothesis 1. 


Where PT is partner tenure; BIG5 equals to 1 if the company is audit by a Big 5 audit firms, otherwise 0; age is the number of years since the company was incorporated; SIZE equals the natural logarithm of the total assets at year-end; GROW equals the growth rate of net sales; CFO equals net cash flows from operations scaled by the beginning total assets.

We estimate the equation (2) to examines the hypothesis 2. 


In this model, we sue the FT to proxy the audit firm tenure. The coefficient of FT indicate the change in discretionary accruals for an extended year of audit firm tenure after controlling audit partner tenure. If the coefficient of FT is not significantly different from 0, the hypothesis is rejected.

This study collects the data form Taiwan Economics Journal (TEJ) database for the year 1990-2001. We delete the non-financial companies, first two years of  initial public offering, start-up companies (defined as less than five years since incorporated), and small industry. The final sample contains 888 companies and 5213 firm-year observations. We try different measures of partner tenure, and also try to control the potential problem of endogeneity in partner tenure with earnings quality. The results show that not only audit partner tenure does not impair earning quality, but also can reduce the upward earnings management. Besides, after controlling the partner tenure, extended audit firm tenure does not impair earnings quality. These results imply that mandatory partner rotation or mandatory firm rotation in additional to partner rotation have reverse effect on earnings quality.
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