Does Auditor Tenure Impact the Effectiveness of Auditorss Response to Fraud Risk?

Abstract

We examine how the effectiveness of the auditor’s response to fraud risk is affected by auditor tenure. Using two different prediction models to identify the risk of fraud (specifically, the M-score developed by Beneish (1997, 1999) and the F-score developed by Dechow et al. (2011)), we identify a sample of company-years where fraud risk is high at the end of the second fiscal quarter, when auditors’ risk assessment procedures are in process. We then examine whether auditor tenure affects the likelihood of a reduction in fraud risk during the remainder of the audit period, when auditors perform most substantive audit procedures. We find that the likelihood of a reduction in fraud risk is greater among companies with longer auditor tenure. In addition, when fraud risk is low at the end of the second fiscal quarter, the likelihood of an increase in fraud risk during the remainder of the audit period is lower among companies with longer auditor tenure. Thus, although regulators and some other stakeholders argue that ‘fresh eyes’ can improve auditor independence and skepticism, we find that auditors with ‘fresh eyes’ are less effective in responding to fraud risk and auditors with greater client experience and familiarity are more effective at responding to this risk. These findings are important because prior work suggests that long auditor tenure is not necessarily beneficial in the post-Sarbanes-Oxley Act era and because regulators continue to debate the benefits and costs of regulation that would shorten auditor tenure on average.