Audit Firm Tenure, Audit Materiality, and Last-Minute Earnings Management

摘要

This study investigates how audit firm tenure affects the propensity for firms to meet or beat earnings benchmarks within audit materiality thresholds. Auditors’ independence can be impaired by either raising quantitative materiality thresholds or neglecting qualitative materiality thresholds. Using tax expense as a proxy for last-minute earnings management (Dhaliwah et al. 2004), we find that the propensity for firms to meet or beat earnings benchmarks within quantitative materiality thresholds is decreasing as tenure lengthens, in contrast to regulator’s concern that extended audit firm tenure erodes auditor independence (PCAOB 2011). Further, we find that the moderating effect of long tenure on tax expense earnings management within materiality thresholds is further enhanced after the SEC’s guidance on materiality in SAB-99 and in the post-SOX period. Our study suggests that mandatory audit firm rotation may negatively affect an auditor’s ability to constrain earnings management, exactly opposite to its intended purpose to enhance audit quality.