Audit Tenure and Audit Quality: Evidence from Turkey

The rise of accounting scandals in the last decade has reduced trust of the \nusers in audited financial statements, so users have started questioning \nthe quality of audit work. This paper aims to test empirically whether \naudit-firm tenure reduces audit quality. After the accounting scandals in \nthe USA and the Europe, and the associated failure of Arthur Andersen, \nbenefits of audit firm or partner rotation on audit quality becomes a \ncontroversial subject. Sarbanes Oxley Act of 2002 considered audit firm \ntenure as a potential area that needed to be investigated because the \nconsecutive years of auditor-client relationship has the potential to impair \nauditor independence. It is argued that the audit quality and therefore the \nquality of general purpose financial statements increase when a new \nauditor with fresh and skeptical eyes evaluates the financial statements. \nUsing the same senior personnel on an audit engagement over a long \nperiod of time believed to create self-interest and familiarity threats to \nindependence (Eilifsen, Messier, Glover and Prawit, 2010). For example, in \nthe Enron case, it appears that the auditors became too familiar with the \ncompany personnel, such that independence in fact and in appearance \nboth may have been compromised (Ryken et al, 2007). Familiarity lead to \nlearned confidence about the results when making assumptions about \noutcomes and using less rigorous audit procedures or static audit \nprograms. \nAccording to the new Independent Audit Communiqué issued in December \n2012 by Turkish Public Oversight Accounting and Auditing Standards Board \n(POAASB), in an audit of the public interest entity, a firm shall not be the \nauditor for more than seven years for the last ten years. In addition to \nthat, an individual shall not be a key audit partner for more than five years \nin the last seven years. After such time the individual shall not be a member of the engagement team or be a key audit partner for the client \nfor two years (Official Gazette, 25809). \nThis paper tests whether a statistically significant association exists \nbetween the audit firm tenure with a client and evidence of reduced audit \nquality as measured by the propensity of modified audit opinions. We \nassume that the decline in audit quality is indicated by the auditor not \nissuing a modified opinion for firms whose financial statements are \nmaterially misstated. Based on a sample of 253 firms listed on İstanbul \nStock Exchange (ISE) and 2277 firm-year observations of audit reports \nduring the 2002-2010 periods, the analysis produces evidence that the \nnumber of consecutive years of audit firm-client relationship negatively \naffects the auditor quality measured by the propensity of modified audit \nopinions. We choose the 2008 and 2009 periods for our main analysis \nbecause in 2010 a mandatory audit firm rotation policy was executed for \nthe companies listed in the ISE. Before this period Turkey has an \nenvironment where the rotation policy is not mandatory. The results of \nthis study are expected to contribute the regulation of the quality of \nauditing by the regulator (POAASB) with regard to auditor rotation. \nKeywords: Audit Tenure, Audit Quality, Audit Opinion, Independence