Audit Partner Tenure and Internal Control Reporting Quality: U.S. Evidence from the Not‐For‐Profit Sector

Abstract

This study examines the effects of audit partner tenure and audit partner changes on internal control reporting quality for large U.S. not‐for‐profit (NFP) organizations. Regulators contend that audit partners lose their objectivity over successive audits, reducing audit quality. A large body of research has examined this issue, primarily in non‐U.S. jurisdictions, with mixed results. We examine the associations between audit partner tenure and audit partner changes and the incidence of reported internal control deficiencies (ICDs), the quality of internal control reports (following PCAOB audit quality indicators), and the severity of reported ICDs. We find negative associations between audit partner tenure and the incidence of reported ICDs, the quality of internal control reports, and the severity of reported ICDs. Together, these findings indicate that internal control reporting quality deteriorates with audit partner tenure. However, we find no association between audit partner changes and internal control reporting, which is consistent with partners lacking client specific knowledge in their first year with a client. Finally, we find no association between either audit partner tenure or changes and the likelihood of remediation. Our findings contribute large‐sample U.S. evidence on the association between audit partner tenure and internal control reporting quality and provide useful information to government regulators, NFP boards charged with the oversight of the external auditor and internal controls, and NFP stakeholders.

On the Economics of Audit Partner Tenure and Rotation: Evidence from PCAOB Data

“…One potential reason for the difference in our findings compared to many prior U.S. (e.g., Manry et al, 2008;Litt et al, 2014;Fitzgerald et al, 2018) or foreign studies (e.g., Chen et al, 2008;Lennox et al, 2014) is that the large sample allows us to estimate "tight" models that include client, year, and audit firm tenure fixed effects, which should control for many of the confounds in audit quality analyses.…”

“…Fitzgerald et al (2018) examine internal control opinions for not-for-profit entities receiving federal funds, as these entities have to obtain internal control audits, for which the engagement partners are identified. They find results consistent with partner capture.15 Laurion et al (2017) …”

“…For instance, studies on the effects of mandatory partner rotation find decreases(Litt, Sharma, Simpson, and Tanyi, 2014), increases(Lennox, Wu, and Zhang, 2014; and Laurion, Lawrence, and Ryans, 2016), and no change(Chi, Huang, Liao, and Xie, 2009) in audit quality. Studies on audit partner tenure find evidence of decreases(Carey and Simnett, 2006;Fitzgerald, Omer, and Thompson, 2018), increases(Chen, Lin, and Lin, 2008;Manry, Mock, and Turner, 2008), or an initial increase followed by a decrease(Chi and Huang, 2005) in audit quality.…”

“…An exception isFitzgerald et al (2018) who study a large sample of U.S. not-for-profit firms. For these entities, audit partner information is publicly available in Federal Audit Clearinghouse filings.…”

Auditing Research: A Review of Recent Research Advances

“…The negative effect of auditor tenure is also documented by Callen and Fang (2017), who found robust evidence that auditor tenure is negatively related to one-year-ahead stock price crash risk. Fitzgerald et al (2018) found that internal control reporting quality deteriorates with audit partner tenure. On the other hand, longer-tenured have also positive effects as studies like those conducted by Goldie et al (2018) and Bae et al (2017) documented.…”