The Association between Auditor Tenure and Fee Dependence and Timely Recognition of Losses

For a sample of clients of Big 6 auditors representing years 1993 through 2001, we examine whether the length of auditor-client relationship is associated with lower conservatism, i.e., the timely recognition of economic losses. The recent spate of accounting scandals has underscored the need for timely recognition of losses and the regulators are probing the role of auditor tenure in enhancing conservatism. We match client observations by year, industry, size, and age and construct two samples: short tenure (two to three years) vs. medium tenure (four to eight years) and short vs. long (nine or more years) tenure. Our findings do not support the notion that conservatism declines as auditor's tenure increases. However, when the fees paid to the auditor are factored in, we find that conservatism is lower for the high nonaudit fees and short tenure observations relative to the low nonaudit fees and short tenure observations. Our findings emphasize the importance of jointly examining fee dependence and auditor tenure on financial reporting quality. Our findings are relevant to investors, auditors, managers, and lawmakers as costs and benefits mandatory rotation for auditors are being debated