Audit Firm Tenure and Fraudulent Financial Reporting

AUDIT FIRM TENURE AND FRAUDULENT FINANCIAL REPORTING Joseph V. Carcello Stokely Distinguished Scholar and Associate Professor University of Tennessee 601 Stokely Management Center Knoxville, TN 37996 (865) 974-1757 jcarcell@utk.edu Albert L. Nagy Assistant Professor John Carroll University January 2004 ACKNOWLEDGEMENTS: We thank Dana Hermanson and Terry Neal, and workshop participants at Georgia State University, particularly Larry Brown and Van Johnson, for their helpful comments on earlier versions of this paper. AUDIT FIRM TENURE AND FRAUDULENT FINANCIAL REPORTING SUMMARY The Sarbanes-Oxley Act (2002) required the U.S. Comptroller General to study the potential effects of requiring the mandatory rotation of audit firms. The General Accounting Office (GAO) concludes in its recently released study of mandatory audit firm rotation that “…mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence” (GAO 2003, Highlights). However, the GAO also suggests that mandatory audit firm rotation may be necessary if the Sarbanes-Oxley Act’s requirements do not lead to an improvement in audit quality (GAO 2003, 5). We examine the relation between audit firm tenure and fraudulent financial reporting. Comparing fraud observations from 1990 through 2001 with both a matched set of non-fraud firms and with the entire population of non-fraud firms, we find that ...