The Effects of Regulated Auditor Tenure on Opinion Shopping in the Korean Market

• In Event: Audit III

Abstract

We examine the impact of regulated auditor tenure on the shopping for favorable audit reports. This study predicts that these regulations may affect auditors’ incentives to compromise and clients’ willingness to engage in opinion shopping. We draw data from the unique Korean setting where both mandatory audit firm retention and mandatory audit firm rotation were implemented for all publicly-listed companies in a staggered manner. Recent findings indicate that certain types of explanatory language are both informative and relevant to investor decision-making (Brazel et al., 2011; Menon et al., 2010; Czerney et al., 2014a, b). To encompass the informational content in audit opinions, we hand collect the audit opinion reports of all listed companies on both the Korean Stock Exchange (KSE) and the Korean Securities Dealers Automated Quotations (KOSDAQ) between 1999 and 2009. Using a text-parsing procedure, we sort audit reports that contain explanatory paragraphs are sorted into 20 categories and code audit reports with potentially negative explanatory language as modified opinions (Lennox 2000, 2002). We find that the level of opinion shopping appears to decrease following the implementation of mandatory audit firm retention but appears to increase following the implementation of mandatory audit firm rotation. Supplemental analysis testing the sensitivity to the definition of negative explanatory language is conducted and the results appear robust. Further analyses reveal that abnormal accruals decrease following mandatory retention and remain unchanged following mandatory rotation. This study adds to the literature by examining the impact of regulated auditor tenure on opinion shopping and by highlighting potential unintended consequences of these regulatory attempts.

Author

• Beu Lee, Texas A&M-San Antonio