gold et al - 2012 -the effect of engagement and review partner tenure and rotation on audit quality - evidence from germany [mapr]

The Effect of Engagement and Review Partner Tenure and Rotation on Audit Quality: Evidence from Germany Anna Gold* VU University Amsterdam anna.gold@vu.nl Friederike Molls Westfälische Wilhelms-Universität Münster friederike.molls@wiwi.uni-muenster.de Christiane Pott Westfälische Wilhelms-Universität Münster christiane.pott@wiwi.uni-muenster.de Christoph Watrin Westfälische Wilhelms-Universität Münster christoph.watrin@wiwi.uni-muenster.de *Corresponding author: Department of Accountancy (PGO); Faculty of Economics and Business Administration; VU University Amsterdam; De Boelelaan 1105; NL-1081 HV Amsterdam; The Netherlands; Tel: +31 20 59 82592 We thank the participants of the 2009 European Accounting Association Annual Meeting, the 2009 Meeting of the Accounting Section of the German Academic Association for Business Research (AS-VHB) in collaboration with the International Association for Accounting Education and Research (IAAER), the 2009 Annual meeting of the German Academic Association for Business Research (VHB), the 2009 EARNet Symposium, and the 2010 AAA American Accounting Association Annual Meeting for many helpful suggestions We greatly appreciate the opportunity to use The Annual-Report-database available from the Chair of Business Administration and Controlling at the Westfälische Wilhelms-Universität Münster All remaining errors are our own Electronic copy available at: http://ssrn.com/abstract=1631947 The Effect of Engagement and Review Partner Tenure and Rotation on Audit Quality: Evidence from Germany Abstract: This study contributes to the recent debate over the effect of audit partner tenure and rotation on auditor independence, expertise and, ultimately, audit quality We investigate the effect of partner tenure and rotation on audit quality, using unique 1995-2010 data from all German listed companies for which we identify not only the audit engagement but also the quality review partner Using multiple absolute and signed values earnings management measures as proxies for audit quality, we find evidence of less income-reducing accounting with an increase in review partner tenure (but not engagement partner tenure) Further, rotation of the review partner (but not the engagement partner) is associated with more income-reducing accounting These findings underline the importance of distinguishing between the two partner roles and support the expertise hypothesis with respect to the review partner Keywords: Audit partner rotation; Audit partner tenure; Audit quality; Review partner JEL descriptors: G34, G38, M41, M42, M48 Electronic copy available at: http://ssrn.com/abstract=1631947 The Effect of Engagement and Review Partner Tenure and Rotation on Audit Quality: Evidence from Germany Introduction The harsh criticism of the auditing profession in the wake of corporate scandals had a significant impact on regulators‘ activities worldwide One issue early on identified as potentially problematic (e.g., AICPA 1977; European Commission 1996) is the possibility of an excessive tenure period for audit partners, the consequence of which might be that the auditor accepts questionable accounting and reporting practices because of familiarity threats and/or in order to retain the client This reasoning is often referred to as the independence hypothesis (e.g., Mautz and Sharaf 1961; AICPA 1978; DeAngelo 1981a; SEC 1994; IFAC 2008) As part of regulatory initiatives world-wide, the Sarbanes-Oxley Act (SOX 2002) now requires rotation of both the audit engagement and review partner every five (previously seven) years Similarly, the 8th EU directive 2006/43/EC (European Commission 2006) requires all 27 EU member states to implement mandatory rotation of both engagement and review partners for audit reports dated after June 2008.1 The major expected benefit is that rotation will improve audit quality because inappropriate accounting practices are more likely identified when a new, and hence more independent, engagement partner assumes responsibility for the audit (Carey and Simnett 2006) Meanwhile, opponents to the rotation Member states are given discretion with regard to the exact rotation period requirement suggest a number of potential pitfalls that may counter the benefits Aside from the additional costs incurred to audit firms, a new partner may lack the client-specific knowledge of risk, operations, and financial reporting practices, which could potentially lead to lower audit quality—an argument known as the expertise hypothesis (e.g., Solomon et al 1999; Johnson et al 2002) Therefore, despite the widely adopted requirement of audit partner rotation, the standard‘s consequences remain unclear and could be either beneficial or harmful for the quality of the audit Recently, a few archival studies in Australia, Taiwan, and the United States have examined tenure and rotation at the within-firm partner level by observing signature changes on audit reports With few exceptions (i.e., Chen et al 2008), results of these studies suggest that (excessive) tenure adversely affects audit quality (Chi and Huang 2005; Carey and Simnett 2006; Manry et al 2008) and that audit quality is higher for firms under a mandatory partner rotation regime than for firms not subject to rotation (Chi et al 2009) Hence, these studies largely support the independence hypothesis While prior studies have focused exclusively on tenure and/or rotation of the engagement partner, relevant standards clearly require rotation of all key partners, hence including the quality review partner (hereafter called ‗review partner‘) alongside the engagement partner (e.g., SOX 2002; European Commission 2006) The purpose of the engagement quality review is to provide quality control for audit engagements and to serve as an evaluation of the performance of the audit engagement partner and team (Epps and Messier 2007) As such, the review partner plays a vital role in the audit review process and for the attainment of a high quality audit; however, no prior research has examined either tenure or rotation effects with respect to the review partner separately In Germany, both partners‘ signatures must be visible and identifiable in the audit report and both partners are formally responsible for the audit (§ 322 HGB of the German Commercial Code) This practice is a characteristic of the dual control principle common in German business law As such, German audit report data offers the unique opportunity to examine tenure and rotation of the review partner separately from the engagement partner by means of the location of their respective signatures in the audit report While (excessive) tenure of the engagement partner has largely been shown to aggravate audit quality and there is some evidence that engagement partner rotation provides a viable solution, dynamics might be significantly different when considering the role of the review partner More specifically the review partner might be relatively less susceptible to independence threats than the engagement partner, because involvement with the client is less extensive and frequent due to the review partner‘s primary role of quality control Further, it is possible that the review partner would primarily benefit from tenure and that rotation might reduce audit quality, because the accumulated experience with the client is not always transferred to a new review partner While refraining from formulating directional hypotheses in this regard, this paper contributes to the literature by examining whether explanations of independence or expertise differ for tenure/rotation effects of the engagement and review partner, respectively Consistent with prior studies (e.g., Chi et al 2009), we examine these effects using absolute and signed performance-matched abnormal accruals as proxies for audit quality We identify a sample of 2,636 firm-year observations for the period 1995-2010 in Germany, hence including a period where partner rotation was legally mandated from 2002 onwards.2 Descriptive results reveal that in the German mandatory rotation setting, rotation occurs even more frequently than the standard requires, such that the mean of partner tenure is less than three years, and the great majority of German firms implement rotation of the review partner (98.56%) and audit engagement partner (99.81%) before the seventh year of tenure Our regression results suggest that tenure of the review partner is associated with an increase in audit quality (reflected by income-decreasing accounting procedures), while rotation of the review partner leads to a significant decrease in audit quality Interestingly, audit quality is not significantly associated with either engagement partner tenure or engagement partner rotation Overall, our paper provides evidence in favor of the expertise hypothesis, but only for the review partner The standard was introduced retro-actively; meaning that engagement and review partners starting in 1995 or earlier were forced to rotate ultimately by 2002 Our study contributes to the debate on mandatory auditor rotation in at least two respects First, in an extension of Chi and Huang (2005), Carey and Simnett (2006), Chen et al (2008), and Manry et al (2008), our analysis provides new empirical evidence by using financial reports on partner (and firm) level rotation and tenure data in a highly developed audit environment, i.e., Germany Second and more importantly, our unique distinction between engagement partner and review partner signatures allows us to differentiate between tenure and rotation of these two partner roles, respectively, and to further disentangle competing hypotheses of expertise and independence Although our findings are in part based on a time period preceding the introduction of mandatory rotation, we believe study results are interesting for policy makers and regulators in countries where empirical investigation of engagement and review partner tenure and rotation is difficult or impossible (e.g., the United States) The remainder of the paper is organized as follows Section describes recent key policy initiatives in the areas of audit partner rotation and the role of the review partner in major jurisdictions (including Germany), reviews related empirical literature, and develops study hypotheses Section discusses the research design, sections and report the empirical results, and section concludes the paper Recent key policy initiatives, literature review and hypotheses Audit partner tenure and rotation Audit partner rotation is required in many countries, but the maximum tenure allowed varies considerably In the 1970s, the United States was the first legislation to require rotation of the audit partner after seven years of tenure on audits of SEC-registered clients With the implementation of SOX in 2002, the rotation period was further reduced to five years for public company engagements and now includes the rotation of both the engagement partner and the review partner Similarly, the Department of Trade and Industry and the U.K Treasury implemented a regulation that requires rotation of the lead engagement partner after five years and of other key engagement partners after seven years By the end of June 2008, all member states of the European Union were required to enact the revised 8th Directive‘s requirements into national law (European Commission 2006) One important detail of the Directive is rotation of the key audit partner,3 but member states are given discretion regarding the maximum tenure allowed Even before the EU Directive was issued, Germany had revised its Commercial Code by means of the ‘Gesetz zur Kontrolle und Transparenz im Unternehmensbereich’ implemented in March 1998, with the rotation requirement The key audit partner is typically the partner that signs the audit report, but may also denote either (a) the statutory auditor(s) designated by an audit firm for a particular audit engagement as being primarily responsible for carrying out the statutory audit on behalf of the audit firm; or (b) in the case of a group audit, at least the statutory auditor(s) designated by an audit firm as being primarily responsible for carrying out the statutory audit at the level of the group and the statutory auditor(s) designated as being primarily responsible at the level of material subsidiaries becoming effective in 2002 As a result, an audit partner was forced to rotate from the engagement if he/she had signed the audit report six times during a ten-year auditor-client relationship The ‘Bilanzrechtsreformgesetz’ in October 2004 modified the existing requirement to a situation where rotation was mandated after a seven-year engagement This law is considered a direct response to SOX (2002) and the European Commission Recommendation (European Commission 2002) (Veltins 2004).4 Next, we discuss prior research and develop hypotheses regarding the potential effects of engagement partner tenure and rotation on audit quality Engagement partner tenure, rotation, and audit quality Audit quality is defined as the joint probability that an auditor will both detect and report material misstatements (DeAngelo 1981b) According to this definition, audit quality is a function of the auditor‘s ability to detect material misstatements (auditor expertise) and to report those detected misstatements (auditor independence) Prior literature and theory explain how the length of the relationship between the auditor and the client (i.e., tenure) may affect audit quality Interestingly, there is an inherent conflict regarding such effects, as As part of this major reform, § 319a HGB was issued for public interest companies This legislation defines circumstances under which an auditor must immediately be excluded from the audit Beyond the reasons stated in § 319 II and III HGB, an auditor is also excluded from the audit of a client using an organized market, as defined in § V Securities Trading Act4 (Wertpapierhandelsgesetz), if the key audit partner(s) has issued (i.e signed) the audit opinion (Bestätigungsvermerk–§ 322 HGB) for seven or more consecutive years (§ 319a I no 4) This requirement is waived if there has been a cooling-off period of three or more years since the last audit reflected by the hypotheses of independence and expertise (e.g., Mautz and Sharaf 1961; Shockley 1981; Iyer and Rama 2004) On one hand, audit quality may be compromised as auditor tenure increases, an argument often referred to as the independence hypothesis More specifically, an increase in audit partner tenure might introduce a familiarity threat to auditor independence (IFAC 2008) The IFAC Code of Ethics states that a ―familiarity threat occurs when, by virtue of a close relationship with an assurance client, its directors, officers or employees, a firm or a member of the assurance team becomes too sympathetic to the client‘s interests‖ (IFAC 2008, p 18) This threat could result in a decline in the audit partner‘s ability to accurately judge the company‘s performance and the client‘s reporting decisions A related explanation is the threat of routine While an audit partner will likely apply creative approaches to audit-testing in the early years of tenure (AICPA 1978; Hoyle 1978; McLaren 1958), deeper knowledge over time about the client‘s systems and control procedures may result in more routine audit programs (Hoyle 1978) Shockley (1981, p 789) asserts that ―complacency, lack of innovation, less rigorous audit procedures and a developed confidence in the client may arise after a long association with the client.‖ The major concern is that prior year audits may cause the partner to anticipate current results instead of carefully and objectively examining the current year‘s data for material misstatements (Arrunada and Paz-Ares 1997) In conclusion, the independence hypothesis References American Institute of Certified Public Accountants (AICPA) 1977 SEC Practice Section’s Reference Manual (SECPS), New York, NY: AICPA American Institute of Certified Public Accountants (AICPA) 1978 The commission on auditor's responsibilities: Report, conclusions and recommendations New York, NY: AICPA Anthony, J H., and K Ramesh 1992 Association between accounting performance measures and stock prices: a test of the life cycle hypothesis Journal of Accounting and Economics 15 (2/3): 203-227 Arrunada, B., and C Paz-Ares 1997 Mandatory rotation of company auditors: A critical examination International Review of Law and Economics 17 (1): 31-61 Ayers, S., and S E Kaplan 2003 Review partners‘ reactions to contact partner risk judgments of prospective clients Auditing: A Journal of Practice & Theory 22 (1): 29–45 Bamber, E M., and L S Bamber 2009 Discussion of ―Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan.‖ Contemporary Accounting Research 26 (2): 393-402 Beck, P., T Frecka, and I Solomon 1988 A model for the market for MAS and audit service: knowledge spillovers and auditor-auditee bonding Journal of Accounting Literature (1): 50-64 Cameran, M., A Prencipe, and M Trombretta 2008 Earnings management, audit tenure and auditor changes: does mandatory auditor rotation improve audit quality? Working Paper, University Bocconi Carcello, J V., and A L Nagy 2004 Audit Firm Tenure and Fraudulent Financial Reporting Auditing: A Journal of Practice & Theory 23 (2): 5569 Carey, P., and R Simnett 2006 Audit partner tenure and audit quality The Accounting Review 81 (3): 653-676 Chen, C.-Y., C.-J Lin, and Y.-C Lin 2008 Audit partner tenure, audit firm tenure, and discretionary accruals: Does long audit tenure impair earnings quality? Contemporary Accounting Research 25 (2): 415-445 Chi, W., and H Huang 2005 Discretionary Accruals, Audit-Firm Tenure and Audit-Partner Tenure: Empirical Evidence from Taiwan Journal of Contemporary Accounting & Economics (1): 65-92 37 Chi, W., H Huang, Y Liao, and H Xie 2009 Mandatory audit partner rotation, audit quality and market perception: Evidence from Taiwan Contemporary Accounting Research 25 (2): 359-391 Collins, D W and P Hribar 2002 Errors in Estimating Accruals: Implications for Empirical Research Journal of Accounting Research 40 (1): 105-134 Davis, L R., B Soo, and G Trompeter 2009 Auditor Tenure and the Ability to Meet or Beat Earnings Forecasts Contemporary Accounting Research (2): 517-548 DeAngelo, L E 1981a Auditor independence, low-balling, and disclosure regulation Journal of Accounting and Economics (2): 113-127 ——— 1981b Auditor size and audit quality Journal of Accounting and Economics (3): 183-199 Dechow, P M., R G Sloan, and A P Sweeny 1995 Detecting earnings management The Accounting Review 70 (2): 193-226 ———, S A Richardson, and A I Tuna 2001 Are benchmark beaters doing anything wrong? Working Paper, University of Michigan Business School ———, and I D Dichev 2002 The quality of accruals and earnings: The role of accrual estimation errors The Accounting Review 77 (Supplement): 35-59 DeFond, M L and K R Subramanyam 1998 Auditor changes and discretionary accruals Journal of Accounting and Economics 25 (1): 35-67 ———, and C W Park 2001 The reversal of abnormal accruals and the market valutation of earnings surprises The Accounting Review 76 (3): 375-404 Dopuch, N., R R King, and R Schwartz 2001 An experimental investigation of retention and rotation requirements Journal of Accounting Research 39 (1): 93-117 Epps, K.K and W F Messier 2007 Engagement quality reviews: A comparison of audit firm practices Auditing: A Journal of Practice and Theory 26 (2): 167-181 European Commission (1996) Green Paper – The role, the position and the liability of the statutory auditor within the European Union COM (96) 338 Brussels Available at http://www.europa.eu.int European Commission 2002 Commission recommendation of 16 May 2002 Statutory auditors' independence in the EU: A set of fundamental principles Official Journal of the European Communities, 19.7.2002, L 191/122-L191/157 38 European Commission 2006 Directive 2006/43/EC of the European Parliament and of the council of 17 May 2006 on statutory audits of annual accounts and consolidated accounts, amending council directives 78/660/EEC and 83/349/EEC and repealing council directive 84/253/EEC Available at: http://eur-lex.europa.eu/ LexUriServ/LexUriServ.do?uri=OJ:L:2006:157:0087:0107:EN:PDF Favere-Marchesi, M., and C Emby 2005 The impact of continuity on concurring partner reviews: An exploratory study Accounting Horizons 19 (1): 1–10 Francis, J R., and D Wang 2008 The joint effect of investor protection and big audits on earnings quality around the world Contemporary Accounting Research 25 (1): 157-191 Gates, S K., D J Lowe, and P M J Reckers 2007 Restoring public confidence in capital markets through auditor rotation Managerial Auditing Journal 22 (1): 5-17 Geiger, M A., and K Raghunandan 2002 Auditor tenure and audit reporting failures Auditing: A Journal of Practice & Theory 21 (1): 67-78 Gelhausen, H.-F 2007 Organisation der Abschlussprüfung, Unterzeichnung von Bestätigungsvermerken und berufsrechtliche Verantwortung WPK Magazin (4): 58-62 Ghosh, A., and C Moon 2005 Auditor Tenure and Perceptions of Audit Quality The Accounting Review 80 (2): 585-612 Greene, W H 2000 Econometric Analysis Englewood Cliffs, NJ: Prentice Hall Hoyle, J 1978 Mandatory auditor rotation: The arguments and an alternative The Journal of Accountancy 145 (5): 69-78 International Federation of Accountants (IFAC) 2008 Code of ethics for professional accountants IFAC Ethics Committee Report: 1-98 Iyer, V M., and D V Rama 2004 Clients' expectations on audit judgments: A note Behavioral Research in Accounting 16 (1): 63-74 Johnson, V E., I K Khurana, and J K Reynolds 2002 Audit-Firm Tenure and the Quality of Financial Reports Contemporary Accounting Research 19 (4): 636-660 Jones, J J 1991 Earnings management during import relief investigations Journal of Accounting Research 29 (2): 193-228 Kaplan, S E., and E G Mauldin 2008 Auditor rotation and the appearance of independence: Evidence from non-professional investors Journal of Accounting and Public Policy 27: 177-192 39 Kasznik, R 1999 On the association between voluntary disclosure and earnings management Journal of Accounting Research 37 (1): 57-81 Kealey, B T., H Y Lee, and M T Stein 2007 The Association between AuditFirm Tenure and Audit Fees Paid to Successor Auditors: Evidence from Arthur Andersen Auditing: A Journal of Practice & Theory 26 (2):95116 Kemp, R S., P M J Reckers, and C E Arrington 1983 Bank credibility: The need to rotate auditors Journal of Retail Banking 5: 38-44 Knapp, M C 1991 Factors that audit committee members use as surrogates for audit quality Auditing: A Journal of Practice & Theory 10 (1): 35-52 Kothari, S P., A J Leone, and C E Wasley 2005 Performance matched discretionary accrual measures Journal of Accounting and Economics 39 (1):163-197 Kraut, M., and R Davidson 1998 Effects of incentives and risks on decisions made by engagement and review partners Northwest Journal of Accounting and Economics: 29-41 Lang, M., and R Lundholm 1993 Cross-sectional determinants of analyst ratings of corporate disclosures Journal of Accounting Research 31 (2): 246-271 Latham, C K., F A Jacobs, and P B Roush 1998 Does auditor tenure matter? Research in Accounting Regulation 12 (23): 165-177 Leuz, C., D Nanda, and P Wysocki 2003 Investor Protection and Earnings Management: An International Comparison Journal of Financial Economics 69 (3): 505-527 Luehlfing, M S., P A Copley, and R A Shockley 1995 An examination of the relationship between audit-related risks and the second partner review Journal of Accounting, Auditing & Finance 10 (1): 43-50 Magee, R P., and M.-C Tseng 1990 Audit pricing and independence The Accounting Review 65 (2): 315-336 Maijoor, S., and A Vanstraelen 2006 Earnings management within Europe: the effects of member state audit environment, audit firm quality and international capital markets Accounting & Business Research 36 (1):3352 Manry, D L., T J Mock, and J L Turner 2008 Does Increased Audit Partner Tenure Reduce Audit Quality? Journal of Accounting, Auditing & Finance 23 (4): 553-572 40 Mansi, S A., W F Maxwell, and D P Miller 2004 Does Auditor Quality and Tenure Matter to Investors? Evidence from the Bond Market Journal of Accounting Research 42 (4): 755-793 Matsumura, M E., and R R Tucker 1995 Second partner review: An analytical model Journal of Accounting, Auditing & Finance 10 (1): 173-200 Mautz, R K., and H A Sharaf 1961 The Philosophy of Auditing, Sarasota, FL McLaren, N L 1958 Rotation of auditors The Journal of Accountancy July: 4144 Myers, J N., L A Myers, and T C Omer 2003 Exploring the term of the auditor-client relationship and the quality of earnings: A case for mandatory auditor rotation? The Accounting Review 78 (3): 779-799 Quick, R 2004 Externe Pflichtrotation–Eine adäquate Maßnahme zur Stärkung der Unabhängigkeit des Abschlussprüfers?, Die Betriebswirtschaft 64 (4): 487-508 Raghunandan, K., L Barry, and J H Evans III 1994 An empirical investigation of problem audits Research in Accounting Regulation (1): 33-58 Rich, J.S., I Solomon and K.T Trotman 1997 The audit review process: A characterization from the persuasion perspective Accounting, Organizations and Society 22 (5): 481-505 Ruiz-Barbadillo, E., N Gómez-Aguilar, and N Carrera 2009 Does Mandatory Audit Firm Rotation Enhance Auditor Independence? Evidence from Spain Auditing: A Journal of Practice & Theory 28 (1): 113-135 Sarbanes-Oxley Act (SOX) 2002 One hundred seventh congress of the United States of America Available at: http://www.sec.gov/about/laws/soa2002.pdf Schneider, A., B K Church, and R J Ramsay 2003 Concurring partner review: Does involvement in audit planning affect objectivity Research in Accounting Regulation 16: 185–195 Securities and Exchange Commission (SEC) 1994 Staff Report on Auditor Independence Chicago, IL: Commerce Clearing House Shockley, R A 1981 Perceptions of auditors' independence: An empirical analysis The Accounting Review 56 (4): 785-800 Solomon, I., M D Shields, and O R Whittington 1999 What industryspecialist auditors know? Journal of Accounting Research 37 (1): 191208 41 Stanley, J D., and F T DeZoort 2007 Audit firm tenure and financial restatements: An analysis of industry specialization and fee effects Journal of Accounting and Public Policy 26: 131-159 Tucker, R R., and E Mae Matsumura 1997 Second-partner review: An experimental economics investigation Auditing: A Journal of Practice & Theory 16 (1): 79-98 Vanstraelen, A 2000 Impact of renewable long-term audit mandates on audit quality European Accounting Review (3): 419-442 Veltins, M A 2004 Verschärfte Unabhängigkeitsanforderungen Abschlussprüfer Der Betrieb 57 (9): 445-452 an Wang, K J and B M Tuttle 2009 The impact of auditor rotation on auditor– client negotiation Accounting, Organizations and Society 34: 222-243 Watts, R L., and J L Zimmerman 1983 Agency problems, auditing, and the theory of the firm: Some evidence Journal of Law and Economics 26 (3): 613-633 ———, and ——— 1986 Positive accounting theory, NJ: Prentice Hall ———, and ——— 1990 Positive accounting theory: A ten year perspective The Accounting Review 65 (1): 131-156 42 TABLE Data description Data available in Compustat 1995-2010 Eliminated data with missing values Available audit report data Remaining Sample 9.597 4.026 2.636 2.636 43 TABLE Summary statistics Panel A: Frequency (percentage) of rotation (engagement partner, review partner, firm partner) during sample period Engagement partner rotation Review partner rotation from engagement to review partner from review to engagement partner from review to engagement partner and engagement to review partner Simultaneous rotation of engagement and review partner Audit firm rotation with engagement partner rotation with review partner rotation with simultaneous rotation of engagement and review partner without any partner rotation and rotation from engagement to review partner and rotation from review to engagement partner and rotation from review to engagement partner and engagement to review partner n (%) 758 (28.76) 687 (26.06) 124 (4.70) 58 (2.20) 19 (0.72) 263 (9.98) 228 (8.65) 189 (7.09) 199 (7.55) 174 (6.60) 24 (0.09) (0.15) (0.19) (0.04) 44 TABLE (Continued) Panel B: Mean years of tenure (firm*, engagement partner, review partner) Variable Firm Tenure Engagement Partner Tenure Review Partner Tenure n=2.636 Firm Tenure Engagement Partner Tenure Review Partner Tenure n=299; DAX30 Firm Tenure Engagement Partner Tenure Review Partner Tenure n=487, MDAX Firm Tenure Engagement Partner Tenure Review Partner Tenure n=303; TecDAX Firm Tenure Engagement Partner Tenure Review Partner Tenure n=368; SDAX Firm Tenure Engagement Partner Tenure Review Partner Tenure n=1.179; CDAX Mean 5.23 2.55 2.80 Median 4.00 2.00 2.00 Std.dev 3.3475 1.6193 1.7402 7.76 3.36 3.30 8.00 3.00 3.00 4.3404 1.8669 1.9223 6.04 2.78 3.04 6.00 2.00 3.00 3.2498 1.7719 1.7079 5.30 2.57 2.86 5.00 2.00 2.00 3.1141 1.5701 1.7616 5.46 2.48 2.75 5.00 2.00 2.00 3.6779 1.5553 1.8054 4.53 2.33 2.62 4.00 2.00 2.00 2.9152 1.4935 1.6634 Notes: * Since we not know for how long switching audit firms audited a given company before 1995, the descriptive details cannot be interpreted as the realworld mean of audit firm tenure 45 TABLE (Continued) Panel C: Descriptive statistics for dependent measures and control variables Variables Primary variables Cashflow Jones Accruals (CF-DACC) Absolute Cashflow Jones Accruals Positive Cashflow Jones Accruals Negative Cashflow Jones Accruals Control variables Firm Tenure Big4 Size Growth Cashflow Lifecycle Mean Median Std.dev 0.00033 0.06969 0.06852 -0.07093 0.00153 0.04204 0.03749 -0.04613 0.10829 0.08286 0.08583 0.07966 4.33763 0.54590 6.02916 0.08817 0.02445 0.53586 4.00 1.0000 5.837563 0.04884 0.03620 0.03243 n 2,636 2,636 1,347 1,289 2.88091 0.49798 2.18880 0.45655 0.17545 8.23201 46 TABLE Cashflow Jones discretionary accruals and engagement or review partner tenure Parameter Absolute CF-DACC (1) Positive CF-DACC (2) Negative CF-DACC (3) Intercept β0 0.2662206 (3.16)*** 0.0301837 (2.56)** -0.3675139 (-4.78)*** EP Tenure β1 RP Tenure β2 0.0011753 (1.15) -0.0017501 (-1.73)* 0.0019166 (1.35) -0.0006667 (-0.54) -0.0006579 (-0.47) 0.0030131 (1.95)* Firm Tenure β3 Big4 β4 Size β5 Growth β6 Cashflow β7 Lifecycle β8 -0.0012946 (-2.07)** 0.0001186 (0.04) -0.0056451 (-6.34)*** 0.018091 (3.70)*** -0.0871874 (-4.54)*** 0.000063 (0.21) -0.0018153 (-2.03)** 0.001291 (0.29) -0.0034405 (-2.76)*** 0.0190616 (3.42)*** -0.1965055 (-7.91)*** -0.0001713 (-2.90)*** 0.0007258 (0.89) -0.0015158 (-0.34) 0.0083244 (6.82)*** -0.0041201 (-0.65) -0.0250186 (-0.91) -0.0015646 (-3.91)*** Included 0.1512 2,636 Included 0.2623 1,347 Included 0.1361 1,289 Fixed industry and year effects adj R-squared No of observations Notes: All variables are winsorized at the 1% and 99% levels Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively *significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed) 47 TABLE Cashflow Jones discretionary accruals and engagement or review partner rotation Parameter Absolute CF-DACC (1) Positive CF-DACC (2) Negative CF-DACC (3) Intercept β0 0.2639556 (3.14)*** 0.0306822 (2.65)*** -0.3587317 (-4.61)*** EPS β1 RPS β2 -0.001742 (-0.47) 0.0080172 (2.06)** -0.0038983 (-0.83) -0.0026696 (-0.55) 0.0023072 (0.44) -0.0166494 (-2.94)*** Firm Tenure β3 Big4 β4 Size β5 Growth β6 Cashflow β7 Lifecycle β8 -0.0013099 (-2.20)** 0.0000911 (0.03) -0.0056443 (-6.31)*** 0.0183621 (3.77)*** -0.0870326 (-4.54)*** 0.0000682 (0.23) -0.001673 (-1.95)* 0.001306 (0.29) -0.0033946 (-2.70)*** 0.0190721 (3.42)*** -0.1970091 (-7.94)*** -0.0001788 (-3.02)*** 0.0008718 (1.14) -0.0016618 (-0.38) 0.0083799 (6.87)*** -0.0049368 (-0.79) -0.024554 (-0.90) -0.0015584 (-3.97)*** Included 0.1519 2,636 Included 0.2623 1,347 Included 0.1412 1,289 Fixed industry and year effects adj R-squared No of observations Notes: All variables are winsorized at the 1% and 99% levels Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively *significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed) 48 TABLE Alternative measures of accruals and engagement or review partner tenure Panel A: Absolute accruals Performance-matched model Modified performance-matched model Abnormal working capital accruals Current accruals Absolute accruals EP tenure RP tenure 0.00057 -0.00262 (0.40) (-1.81)* 0.00124 -0.00265 (0.86) (-1.83)* 0.00114 -0.00348 (0.67) (-2.02)** 0.00071 -0.00127 (0.46) (-0.79) Panel B: Positive and negative accruals Performance-matched Model Modified performance-matched model Abnormal working capital accruals Current accruals Positive accruals EP RP tenure tenure 0.00082 -0.00173 (0.44) (-0.99) 0.00084 -0.00108 (0.45) (-0.64) 0.00136 0.00005 (0.71) (0.03) 0.00047 -0.00025 (0.26) (-0.14) Negative accruals EP RP tenure tenure -0.00197 0.00298 (-1.06) (1.53) -0.00270 0.00383 (-1.45) (1.97)** -0.00084 0.00477 (-0.35) (1.92)* -0.00251 0.00258 (-1.28) (1.22) Notes: All variables are winsorized at the 1% and 99% levels Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively *significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed) 49 TABLE Alternative measures of accruals and engagement or review partner rotation Panel A: Absolute accruals Absolute accruals Performance-matched model Modified performance-matched model Abnormal working capital accruals Current accruals EPS 0.00070 (0.14) -0.00133 (-0.27) -0.00611 (-1.07) -0.00159 (-0.27) RPS 0.01287 (2.43)** 0.01406 (2.60)*** 0.01784 (2.62)*** 0.01092 (1.76)* Positive accruals EPS RPS 0.00021 0.00892 (0.03) (1.22) 0.00054 0.00684 (0.08) (0.95) -0.00764 -0.00179 (-1.21) (-0.26) -0.00371 0.00207 (-0.53) (0.32) Negative accruals EPS RPS 0.00501 -0.01090 (0.81) (-1.70)* 0.00857 -0.01514 (1.44) (-2.38)** 0.00912 -0.02466 (1.11) (-2.47)** 0.00621 -0.01688 (0.93) (-2.16)** Panel B: Positive and negative accruals Performance-matched model Modified performance-matched model Abnormal working capital accruals Current accruals Notes: All variables are winsorized at the 1% and 99% levels Robust t-statistics and z-statistics clustered by firm are in parentheses respectively *significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed) 50 TABLE Correlation matrix EPS RPS EPS 0.2008 (0.0000) 0.0606 (0.0035) -0.5201 (0.0000) -0.051 (0.0141) Review partner tenure RPS Tenure Engagement partner tenure Tenure Engagement Partner tenure Review Partner tenure 0.082 (0.0001) -0.0522 0.3401 (0.012) (0.0000) -0.4993 0.3395 (0.0000) (0.0000) 0.4034 (0.0000) 51 ... with audit quality Next, we consider how tenure and rotation of the review partner may affect audit quality Quality review partner tenure, rotation, and audit quality The general purpose of the engagement. .. research and develop hypotheses regarding the potential effects of engagement partner tenure and rotation on audit quality Engagement partner tenure, rotation, and audit quality Audit quality is... review partner rotation with simultaneous rotation of engagement and review partner without any partner rotation and rotation from engagement to review partner and rotation from review to engagement