Estimates of Optimal Audit Firm Tenure Across Different Legal Regimes

Abstract

Based on a quadratic form of audit tenure in explaining audit quality, we estimate a reference point that is potentially optimal for audit firm rotation for 22 countries across legal regimes with high versus low levels of investor protection. We find that our estimate for the high investor protection regime is longer than that for the low investor protection regime (24 years vs. 14 years for our main measure). However, very few firms from our sample would have been affected if there were a requirement of a mandatory rotation term, suggesting that mandatory audit firm rotation may not be necessary. In additional analyses, we not only evaluate the empirical validity of the quadratic form but also use various measures of our key variables, to conduct several other robustness tests. We continue to find a longer optimal point for countries with stronger investor protection in these robustness tests. Our findings imply that stronger country-level investor protection is a substitute for a shorter term of mandatory audit firm rotation.