Estimates of Optimal Audit Firm Tenures across Different Legal Regimes

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 the estimate for the low investor protection regime (e.g., 24 years versus 14 years for our main measures). However, very few firms from our sample would have been affected if there were a requirement of such a mandatory rotation term, suggesting that mandatory audit firm rotation may not be necessary. We validate the empirical validity of the quadratic form, use various measures of our key variables and conduct a battery of tests to control for endogeneity and survivorship bias; and we continue to find a longer optimal point for countries with stronger investor protection. Our findings imply that stronger country-level investor protection is a substitute for a shorter term of mandatory audit firm rotation.