Audit Firm Tenure, Intertemporal Comparability, and Corporate Bond Rating Properties

• In Event: Individual Auditor Effects on Audit Quality

Abstract

This study examines the effect of audit firm tenure on both intertemporal comparability of financial statements and credit rating accuracy. Building on the prior literature on auditor tenure and auditor styles, we posit that as auditor tenure increases, auditors accumulate client-specific knowledge and expertise over time, which facilitates the use of a particular auditor style in auditing clients’ financial statements, and hence increases intertemporal comparability. With higher intertemporal comparability, credit rating agencies can better predict future firm performance and credit risk, which in turn improves rating accuracy. Working against the benefits of auditor tenure is the possible impairment of auditors’ objectivity as tenure increases. We find that intertemporal comparability improves with auditor tenure. We also find that as auditor tenure lengthens, rating accuracy increases. Our results are robust to a series of robustness checks and additional analyses, including a difference-in-difference approach that uses the demise of Arthur Anderson as an exogenous shock to auditor tenure. Our study has implications for regulators who continue to be concerned about lengthy auditor-client relationships.

Authors

• Xia Zhang, University of Washington - Tacoma

• Sam Bonsall, Ohio State University

• Inder K Khurana, University of Missouri-Columbia