WHEN DOES AUDIT QUALITY START TO DECLINE IN FIRM AUDIT TENURE? - AN INTERNATIONAL ANALYSIS

This paper investigates the decline in audit quality during an audit firm’s tenure acrosscountries with varying degrees of legal liability. We propose that audit quality can increasethrough a learning effect in early years but in later years it is likely to decrease due to a bondingeffect. Using a quadratic model, we estimate the year when audit quality, measured by earningsquality, starts to decline during an audit firm’s tenure. We propose that the bonding effect shouldbe weaker in countries with stricter legal liability regimes, which implies that the year that auditquality begins to decline should be later in countries with stricter legal liability regimes. We findthat it takes 14 to 16 years for countries with stronger legal liability regimes while it only takes 4to 10 years for countries with weaker legal liability regimes for audit quality to decline. Ourresults are strong regardless of whether we measure legal liability from the perspective of legalorigin (common or code law) or litigation risk. Our findings have implications across the worldfor the current debate on the mandatory requirement of audit firm rotation across the world.