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

• In Event: Effects of Audits on Investors and Jurors

Abstract

In 2017 the PCAOB began requiring audit firm tenure disclosure within the audit report for SEC
registrant clients. Many commenters raised concern that prominent disclosure of firm tenure in the
audit report will lead investors to inappropriately infer a negative relationship between audit
quality and long firm tenure. This is particularly troubling given that empirical evidence generally
does not support this concern. Using psychology research on entitativity (a cognitive process
through which individuals attribute varying degrees of interconnectedness among others), we
predict and find disclosing an audit firm’s long tenure within the audit report increases investors’
perceptions of entitativity between the audit firm and client, and thus reduces investors’ beliefs
that the auditor was independent while conducting the audit. We also identify a treatment to
mitigate the effects of reporting long firm tenure—disclosure of a firm’s adherence to the SEC’s
mandatory partner rotation requirement. Specifically, 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
useful to regulators in understanding one effect of their standard, and to audit firms because of
their autonomy over adding engagement partner rotation protocols to their audit reports and
potentially mitigating the effect of firm tenure disclosure.

Authors

• Brian Matthew Goodson, Clemson University

• Chad Matthew Stefaniak, University of South Carolina

• Sarah Judge, Indiana University