Audit Firm Tenure and Nonprofessional Investors’ Perceptions of Entitativity and Independence Impairment: The Mitigating Effect of Partner Rotation Disclosure

• In Event: Auditor Independence

Abstract

In 2019 the PCAOB began requiring audit firm tenure disclosure within the auditor’s report for SEC registrant clients. During the standard-setting process, many commenters raised concerns that prominent disclosure of firm tenure in the auditor’s report would lead investors to inappropriately infer a negative relationship between audit quality and long firm tenure. This is particularly troubling given a review of the literature suggests a generally neutral or positive relation between firm tenure and audit quality (Tepalagul and Lin’s 2015). We use entitativity research (a cognitive process through which individuals attribute varying degrees of interconnectedness among others) to predict and find disclosing an audit firm’s long tenure within the auditor’s report significantly increases perceptions of entitativity, and thus reduces investors’ beliefs that the auditor was independent while conducting the audit. We further identify a treatment to mitigate the effects of long firm tenure disclosure – disclosure of a firm’s adherence to the SEC’s mandatory partner rotation requirement. We predict and find partner rotation disclosure moderates the mediation of firm tenure on investors’ judgments such that the indirect effect through entitativity operates only when partner rotation is not disclosed in the auditor’s report. Our results should be not only useful for regulators to understand one effect of their standard, but also for firms because of their autonomy to voluntarily add engagement partner rotation protocols to their auditor’s reports and potentially mitigate this disclosure effect.

Authors

• Sarah Judge, Indiana University

• Brian Matthew Goodson, Clemson University

• Chad Matthew Stefaniak, University of South Carolina