The Effects of Auditor Tenure on Fraud and Its Detection

• In Event: Conflicts of Interest, Fraud & Audit Quality

Abstract

Security market regulators have long debated the potential effects of firms hiring the same auditor over multiple periods. Some believe that longer auditor tenure increases the probability that material misstatements go undetected while others believe that this makes the auditor more capable of detecting material misstatements. Empirical studies have provided mixed results concerning the effects of auditor tenure. However, the effectiveness of strategic auditing cannot be measured solely by empirical outcomes. We must also consider the auditor’s unobservable actions that deter fraud.
The purpose of this paper is to examine the strategic effects of multi-period audits where the accumulation of audit evidence over time affects the auditor’s testing strategy and the manager’s inclination to commit fraud. We study a two-period setting and find strategic interactions between periods only when a continuing auditor audits both periods. Moreover, expected undetected fraud and audit risk over both periods are less given a continuing auditor.

Authors

• Evelyn R Patterson, Indiana University - Indianapolis

• Reed Smith, Indiana University - Indianapolis