Independent and Joint Effects of Audit Partner Tenure and Non-Audit Fees On Audit Quality

Journal of Contemporary Accounting and Economics 15 (2019) 186–205
Contents lists available at ScienceDirect
Journal of Contemporary
Accounting and Economics
journal homepage: www.elsevier.com/locate/jcae
Independent and joint effects of audit partner tenure

and non-audit fees on audit quality
Abhijeet Singh ⇑, Harjinder Singh, Nigar Sultana, John Evans
School of Accounting, Curtin University, Perth, Australia
articleinfo abstract
Article history: We examine the individual and joint effects of auditors’ non-audit services (NAS)/abnormal
Received 17 October 2017 NAS fees and length of audit partner tenure on audit quality. Our results raise questions
Revised 19 March 2019 about the ‘one size fits all’ approach imposed by the current audit partner rotation require-
Accepted 25 March 2019 ment in Australia as a result of (1) a learning differentiation that we observe between Big 4
Available online 11 April 2019 and non-Big 4 auditors and (2) higher discretionary accruals associated with non-Big 4
auditors. We find abnormal NAS fees to have a positive association with both absolute
JEL classification: and positive (income-increasing) values of discretionary accruals for firms with short audit
G18 partner tenure. NAS/abnormal NAS fees are also negatively associated with the issuance of
M41 going concern opinions to financially distressed firms when partner tenure is short. In
M42
terms of policy implications, regulators are able to gauge the efficacy of the CLERP 9
Keywords:
reforms which currently impose a five year mandatory audit partner rotation requirement.
Audit quality Crown Copyright © 2019 Published by Elsevier Ltd. All rights reserved.
Auditor tenure
Non-audit services
Auditor independence
1. Introduction
We examine the individual and joint effects of auditors’ non-audit services (NAS)/abnormal NAS fees and the length of
audit partner tenure on audit quality in Australia after the passage of the Corporate Law Economic Reform Program Act
2004 (CLERP 9). Questions on whether NAS fees and auditor tenure impair auditor independence, and consequently, audit
quality have attracted considerable attention from investors, regulators, researchers, and the financial press. There appears
to be an apparent tension between regulatory policy requirements and evidence on the effects of auditor provided NAS fees
(DeFond and Zhang, 2014; Eilifsen and Knivsflå, 2016) and audit partner rotations (Daugherty et al., 2012; Laurion et al.,
2017). Our study seeks to inform policymakers who continue to mandate new regulations in these areas (Accounting
Professional & Ethical Standards Board, 2017; European Union, 2014).
While corporate governance reforms such as CLERP 9 significantly altered the financial reporting and auditing landscape
in Australia, there is little empirical evidence on the effects of CLERP 9 on auditor independence and audit quality (Carey
et al., 2014). Prior studies such as Ye et al. (2011) examined the individual effects of auditor provided NAS fees and length
of audit engagement partner tenure on auditor independence before the CLERP 9 Act (1) imposed regulatory restrictions on
audit partner tenure and (2) made statutory changes in the area of NAS. Other studies such as Hossain (2013) examined the
effects of auditor NAS/abnormal NAS fees on audit quality in the pre- and post-CLERP 9 periods. In this study, we integrate
two strands of audit literature by examining the effects of audit partner tenure on the association between auditor NAS/
⇑ Corresponding author at: Curtin University, Perth, Western Australia, Australia.

E-mail address: Abhijeet.S@cbs.curtin.edu.au (A. Singh).
https://doi.org/10.1016/j.jcae.2019.04.005
1815-5669/Crown Copyright © 2019 Published by Elsevier Ltd. All rights reserved.
A. Singh et al. / Journal of Contemporary Accounting and Economics 15 (2019) 186–205 187
abnormal NAS fees and audit quality in the post-CLERP 9 period. An investigation of the relationship between NAS fees and
auditor independence/audit quality without considering auditor tenure is likely to provide an incomplete picture given the
pivotal influence of auditor tenure on audit quality (Gul et al., 2007).
Prior literature provides mixed evidence on the association between the length of audit partner tenure and audit quality
(Carey and Simnett, 2006; Chen et al., 2008). Daugherty et al. (2012) argue that while mandatory partner rotation may
increase auditor independence by bringing ‘‘fresh eyes” to examine client risk and engagement issues, this occurs at t he
expense of lost organizational knowledge related to client specific matters which may adversely impact audit quality. Con -
sistent with Daugherty et al. (2012), we expect longer partner tenure to be associated with higher audit quality since clients
are likely to exploit the information disadvantage of a new audit partner and that some level of familiarity enhances the
audit process. We also expect stronger partner tenure effects to apply to non-Big 4 auditors, since non-Big 4 auditors have
been associated with higher discretionary accruals (DeFond and Zhang, 2014) and a learning disadvantage compared to Big 4
auditors (Chi and Huang, 2005).
In prior research, Gul et al. (2007) provide evidence suggesting NAS fees may impair auditor independence when audit firm
tenure is short. We conjecture that NAS/abnormal NAS fees are also likely to affect audit quality for firms with short audit
partner tenure. Economic bonding has been found in prior literature to drive auditor behavior (Hoitash et al., 2007) and
the possible loss of lucrative NAS fees may make the incoming partner more tolerant to client reporting discretion. Non -
audit services have been previously associated with hindering auditor resignations for reasons of profitability (Stefaniak
et al., 2009; Ye et al., 2011) and hence are likely to induce greater (negative) economic incentives in an audit partner rotation
setting wherein the inflow of rents from client firms is not interrupted. Furthermore, the results from the study by Daugherty
et al. (2012) suggest that mandatory partner rotation increases the workload of the incoming lead partner, the outgoing lead
partner, and other engagement team members in the initial year of rotation. These factors are likely to contribute to the neg -
ative association between NAS/abnormal NAS fees and audit quality for firms with short audit partner tenure.
Our results provide evidence of significantly higher levels of discretionary accruals for non-Big 4 auditors and also suggest
a learning differentiation between Big 4 and non-Big 4 auditors. We find a significant negative association between the
length of partner tenure and earnings management and determine that this relationship is primarily driven by non -Big 4
auditors. Big 4 auditors are found to be significantly more capable during the initial audit engagement period in constrainin g
earnings management and improving audit quality.
Similar to findings from Hossain (2013), our results using the total sample without considering audit partner tenure show
that there is no significant association between NAS/abnormal NAS fees and audit quality. The association between
NAS/abnormal NAS fees and audit quality becomes clear when we include audit partner tenure in the analyses, as we find
a significant positive association between abnormal NAS fees and earnings management when partner tenure is short
(i.e. 2 years or less). When we split the sample into positive (income-increasing) discretionary accruals and negative
(income-decreasing) discretionary accruals, we find abnormal NAS fees and short partner tenure to be associated with higher
positive discretionary accruals, but not with negative discretionary accruals, indicating an upward adjustment of reported
earnings when abnormal NAS fees are high and audit partner tenure is short. We also find a significant negative association
between NAS/abnormal NAS fees and issuance of going-concern opinions to financially distressed firms when partner tenure
is short. In case of both audit quality proxies, namely, discretionary accruals and issuance of going-concern opinions, we find
these results to be driven by firm-years where incoming partner is from the same firm as the outgoing partner. Our results
show that the relationship between NAS/abnormal NAS fees and audit quality is conditional on audit partner tenure.
Our study makes the following contributions. First, to the best of our knowledge, ours is the first study to examine both
the individual and joint effects of auditor NAS/abnormal NAS fees and length of audit partner tenure on audit quality after
the introduction of major auditor regulatory reforms from CLERP 9. Second, our findings suggest that the learning obtained
through longer partner tenure is crucial for non-Big 4 auditors to improve the audit quality of their clients and support con-
cerns in prior literature about the ‘‘one size fits all” requirement for mandatory audit partner rotation (Chi and Huang, 2005).
Regulators should therefore pay closer attention to the expected negative effects of mandatory partner rotation on audit
quality from non-Big 4 auditors, who are also found to be associated with higher discretionary accruals compared to the
Big 4. Based on our findings, it may be necessary to apply the audit partner rotation requirements differentially to clients
of auditors; for example, Big 4 compared to non-Big 4 audit firms. Third, our study complements and extends existing
literature on the impact of NAS/abnormal NAS fees on audit quality in the post-CLERP 9 period. Our findings provide
evidence that the association between NAS/abnormal NAS fees and audit quality is contingent upon audit partner tenure.
This study will help policymakers and regulators better determine the effects of policies surrounding audit partner rota-
tion requirements and NAS disclosure on the audit quality of firms. The identification of audit partners in Australia allows a
more comprehensive and detailed analysis of auditor tenure compared to other jurisdictions such as the US, which until
recently was hampered by disclosures of tenure based solely on the audit firm (Public Company Accounting Oversight
Board, 2015).
2. Regulatory changes
Our motivation to focus on non-audit services and audit partner rotation in the post-CLERP 9 period stems from the statu-
tory changes (amendments to Corporations Act (2001) – Commonwealth of Australia) that were made in these areas (with
188 A. Singh et al. / Journal of Contemporary Accounting and Economics 15 (2019) 186–205
the objective of improving auditor independence) via the adoption of the CLERP 9 Act, effective for the reporting periods after
1 July 2004.
Regulators and legislators have been concerned whether the joint provision of audit and non-audit services compromises
auditor independence and reduces audit quality (Corporate Law Economic Reform Program, 2004; European Union, 2014;
Sarbanes-Oxley Act, 2002). Concerns raised by Sarbanes-Oxley Act (SOX) in the US surrounding the perceived lack of inde-
pendence with same firms providing audit and consulting services to their clients led the Big 5 (now Big 4) accounting firms
to reconsider their business models (Mcclelland and Stanton, 2004). The effects of these changes flowed onto the Australian
offices of these firms although they were subjected to less stricter CLERP 9 proposals (The Treasury, 2002).1 Specifically,
Arthur Andersen spun off Accenture in August 2000 and subsequently built a business consulting division before it ceased oper-
ation in August 2002. Three of the remaining Big 4 accounting firms also spun off their consulting arms between 2000 and 2002.
Ernst & Young (EY), PricewaterhouseCoopers (PwC) and KPMG sold their IT consultancy divisions to Cap Gemini, IBM and Bear-
ingPoint, respectively (The Treasury, 2002). The three accounting firms, however, retained other non-audit services including
tax, legal, corporate recovery, corporate finance, transaction services, and forensic accounting. Deloitte Touche Tohmatsu
(DTT) was the only one of the Big 4 accounting firms that decided against separating itself from its IT consulting unit called
Braxton as a result of adverse conditions in the capital market. Business growth in consultancy was also experienced by many
second tier accounting firms such as William Buck through the provision of non-audit services and the acquisition of non-audit
service providers (The Treasury, 2002). Furthermore, with effect from 1 July 2006, CLERP 9 also amended the Corporations Act
(2001) so as to require mandatory rotations of audit partners every five years.2
3. Development of hypotheses
3.1. Audit partner tenure and audit quality
Restrictions on auditor tenure have been examined at two levels in the prior literature: (1) firm level and (2) partner level.
The auditing profession has largely opposed auditor rotation at the firm level by supporting the auditor expertise hypothesis,
which proposes that lengthier audit firm tenure reduces information asymmetry between clients and auditors over time as
auditors acquire the client-specific knowledge necessary to enhance audit quality, and also that mandatory audit firm rota-
tion is costly (American Institute of Certified Public Accountants, 1992; Ernst & Young, 2011).
Whilst a change in audit partner as a result of partner rotation has been argued to less likely create a steep learning curve
about the client’s operations for the new partner, prior research has generally shown audit quality to be indelib ly tied with
experiences of individual professionals and their deep personal knowledge of clients (Chi and Chin, 2011; Krishnan, 2003). It
is argued that mandatory partner rotation may increase auditor independence with auditors taking a fresh look at client risk
and engagement issues at the expense of lost institutional knowledge related to client specific matters, thereby making
knowledge transfer strategies between audit partners and other members of the audit engagement team to be of critical
importance (Daugherty et al., 2012).
Studies investigating the relationship between auditor tenure and aggressive earnings management behavior in the pre -
SOX period generally support the concerns of the auditing profession by reporting a decrease in accruals -based earnings
management with increased auditor tenure (Gul et al., 2007; Myers et al., 2003). Unlike previous US studies, however,
Davis et al. (2009) find a nonlinear relationship between audit firm tenure and earnings quality, showing that both short
auditor tenure (three years or less) and long auditor tenure (beyond fifteen years) are associated with greater auditor toler -
ance of earnings management in the pre-SOX period. They also find no relationship between the length of audit firm tenure
and accruals-based earnings management following the passage of SOX.
Unlike US studies, archival research from countries requiring mandatory audit partner rotation, such as Taiwan, Germany,
and Australia, has generally focused on audit partner tenure when examining earnings quality and audit quality (Bamber and
Bamber, 2009).3 In Australia, while Hamilton et al. (2005) and Fargher et al. (2008) find audit partner rotation to increase audit
1
Section 201 of SOX implemented by the US Securities and Exchange Commission (2003) banned the provision of a number of non-audit services, including
bookkeeping, financial information systems design and implementation, appraisal services and the like, actuarial services, internal audit outsourcing services,
management functions or human resources, broker or dealer (including investment adviser) services, legal services, and any other service that the Public
Company Accounting Oversight Board determines. Prior approval was made necessary by a registrant’s independent audit committe e of any non-audit service
allowed by law. While CLERP 9 does not prohibit the provision of any particular non-audit service by the auditor, section 300(11) of the Corporations Act (2001)
requires the boards of all listed companies to include in the annual report details of the amounts paid or payable to the auditor for non-audit services provided,
a statement whether the provision of non-audit services is compatible with the general standard of auditor independence imposed by the Act, and an
explanation why the provision of the services did not impair auditor independence.
2
Section 324 of the Corporations Act (2001) requires that where an individual plays a significant role in the audit of a liste d entity for five successive financial
years, the individual cannot play a significant role in the audit of that entity until another two successive financial years have passed. Such changes generally
impact the lead auditor (engagement partner) and the review auditor (concurring or the review partner).
3
Effective from 2006, the Eighth Directive of the European Commission requires that in all 27 European Union member states, engagement partners must
sign the auditor’s report in their own name on behalf of the registered audit firm (European Parliament and the Council of the European Union, 2006). Prior to
this directive, a number of European countries including Germany, Luxembourg, and France required disclosure of the engagement partner’s identity through
signature for a number of years (Institute of Chartered Accountants in England and Wales, 2006). The Australian jurisdiction has similarly required the
engagement partner’s personal signature and the audit firm’s name since the 1970s (Carey and Simnett, 2006), while Taiwan has since 1983 required personal
certification of audit reports by two engagement partners on behalf of the audit firm (Chi and Huang, 2005).
quality by better limiting the accounting discretion of client managers during the initial years of engagement, Carey and Simnett
(2006) find short partner tenure of two or fewer years to be associated with greater earnings management.4 While the empirical
literature in Australia is mixed, consistent with the general findings that clients exploit the information disadvantage of a new
auditor and that familiarity supports the auditing process and enhances audit quality, the following hypothesis is proposed to
test the association between engagement partner tenure and earnings management:
H1a. Client firms with longer audit partner tenure have lower earnings management than client firms with shorter audit partner
tenure.
Scholars such as Chi and Huang (2005) previously provided evidence in support of learning differentiation between the
Big 5 (now Big 4) and non-Big 5 auditors by showing that Big 5 auditors are significantly more proficient during the initial
audit engagement period in constraining earnings management and improving audit quality. Compared to Big 4 auditors,
non-Big 4 auditors have also been associated with higher discretionary accruals (DeFond and Zhang, 2014; Francis et al.,
1999). Thus, to test whether the partner tenure effects are stronger for auditors from non-Big 4 firms, the following hypoth-
esis is proposed:
H1b. Client firms of non-Big 4 auditors with longer audit partner tenure have lower earnings management than client firms with
shorter audit partner tenure.
3.2. Auditor NAS/abnormal NAS fees and audit quality
Studies using US data from the pre-SOX period, when firms were required to disclose NAS fees paid to auditors before
most non-audit services were prohibited by SOX, provide mixed evidence for the association between NAS purchase and
earnings management. While scholars such as Ashbaugh-Skaife et al. (2003) find NAS fees to be positively associated with
earnings management and thus support regulatory concerns based on the economic bonding hypothesis, 5 others such as Koh,
Rajgopal, and Srinivasan (2013) find NAS fees to be negatively associated with earnings management and thus support the
knowledge spillover hypothesis. 6 Scholars such as Larcker and Richardson (2004) find the association between NAS fees and
earnings management to be contingent on a client’s characteristics and corporate governance. On comparing earnings manage-
ment practices exhibited by sample firms for a pre-SOX period and a post-SOX period, Krishnan et al. (2011) find firms with
higher reduction in NAS fees to be associated with greater declines in earnings management, suggesting a positive association
exists between the amount of NAS fees and the earnings management and that the earnings management behavior prevalent in
the US firms was higher in the pre-SOX period.
Like US studies, Australian studies have also provided mixed evidence on the impact of NAS purchase on auditor indepen-
dence and audit quality. Ruddock et al. (2006) do not find higher levels of NAS fees to be associated with reduced earnings
conservatism and, consequently, reduced audit quality. In contrast, Hossain (2013) finds NAS fees to be associated with
reduced audit quality in the form of higher earnings management and lesser issuance of going-concern opinions.
An auditor’s objectivity and independence is more likely to be influenced by abnormal fees, i.e., client fees in excess of an
auditor’s expectation of normal fees that primarily reflect the auditor’s effort cost and litigation risk. In terms of the eco-
nomic bonding hypothesis, Choi et al. (2010) argue that auditors receiving unusually high audit fees from clients may con-
sider the benefits of retaining such profitable clients to outweigh the costs of allowing substandard reporting in terms of
increased litigation risk, reputation loss, etc. Strong economic bonding has been argued to negatively affect the quality of
reported earnings by reducing an auditor’s willingness to resist client-induced bias in reported accounting information
(Kinney and Libby, 2002). Hoitash et al. (2007) find evidence consistent with the view that client firms with higher abnormal
NAS fees may have greater influence on auditors’ decisions, impairing auditor independence. Hossain (2013) finds a signif-
icant negative association between abnormal NAS fees and audit quality pre-CLERP 9, but not post-CLERP 9.
The empirical evidence surrounding the impact of NAS/abnormal NAS on audit quality remains mixed. Thus, the following
hypotheses are proposed in null form to test the association between NAS/abnormal NAS fees and earnings management:
H2a. There is no significant association between NAS fees and earnings management practices exhibited by client firms.
H2b. There is no significant association between abnormal NAS fees and earnings management practices exhibited by client f irms.
4
Engagement partners can be identified in the Australian jurisdiction as Section 324 (10) of the Corporations Act (2001), Comm onwealth of Australia,
requires the auditor’s report to be signed by the partner-in-charge of the audit engagement.
5
Advocates of the economic bonding hypothesis argue that an audit firm procuring a high level of NAS fees (and hence total fees) from its clients is likely to
permit higher levels of earnings manipulation, thereby compromising the reliability and quality of financial reporting, to maximize its potential to retain these
clients due to greater incremental economic bonding and the potential loss of lucrative NAS revenues (Wallman, 1996).
6
Advocates of the knowledge spillover hypothesis argue that providing both audit and non-audit services can improve auditing efficiency and effectiveness
through enhanced economies of scope via knowledge spillover from the auditor’s increased knowledge of the client, thereby increasing auditor objectivity and
independence (Simunic, 1984).
3.3. Audit partner tenure, auditor NAS/abnormal NAS fees and audit quality
Scholars such as Gul et al. (2007) find the association between NAS fees and earnings management to be contingent upon
auditor attributes such as auditor tenure. They find higher NAS fees to be associated with higher discretionary accruals when
audit firm tenure is short. In support of their findings, Gul et al. (2007) argue that audit firms with shorter tenure are likely to
place greater emphasis on profits in the form of quasi rents compared to reputation protection and be more accommodating
in the early years of the audit engagement as a result of the competitive practice of low-balling. Gul et al. (2007) also argue
that audit firms may face special audit problems earlier in their tenure resulting from unfamiliarity with the client’s busi-
ness, thereby, making the detection of earnings management possibly more difficult.
While audit partner rotation avoids the threat of familiarity between the audit partner and the client’s representatives, it
does not limit the number of years for which the incumbent auditor can derive future quasi rents. Hence, the auditor might
be less independent in an audit partner rotation regime since the size of outstanding payoffs is higher. Using Australian data,
Stewart et al. (2016) find higher audit fees in the year of audit partner rotation. In their submission to the Public Company
Accounting Oversight Board, Grant Thornton (2011) acknowledged that ‘no partner wants to be the one to lose a significant
or long standing relationship.’
The provision of non-audit services is particularly likely to induce economic incentives in an audit partner rotation set-
ting. Audit partner rotations do not interrupt the inflow of rents from client firms with non-audit services likely to create
greater (negative) economic incentives in such an environment. Non-audit services have been recognized as a factor in
potentially hindering auditor resignations for reasons of profitability (Stefaniak et al., 2009; Ye et al., 2011). Aschauer and
Quick (2018) provide experimental evidence showing that an audit partner rotation regime which allows audit firm-
provided non-audit services such as tax services generates the lowest assessments of auditor independence and audit quality.
In addition to the above arguments, audit partner rotations may also contribute to the positive association between NAS/
abnormal NAS fees and earnings management as a result of the incoming partner’s unfamiliarity with the client. Daugherty
et al. (2012) report mandatory partner rotation to increase the workload of the incoming lead partner, the outgoing lead
partner, and other engagement team members in the initial year of rotation and it takes, on an average, two to three years
for audit partners to familiarize themselves with new clients and become fully effective on their new audit assignments.
Based on the above discussions, we propose the following hypotheses to test the effect of audit partner tenure on the
association between auditor NAS/abnormal NAS fees and earnings management:
H3a. There is a positive association between NAS fees and earnings management when audit partner tenure is short.
H3b. There is a positive association between abnormal NAS fees and earnings management when audit partner tenure is short.
4. Research method
4.1. Earnings management models
We use discretionary accruals (an indicator of earnings management) to measure audit quality. The first model to esti-
mate discretionary accruals using total accruals for the main tests is the cross-sectional version of Dechow et al. (1995) mod-
ified Jones model defined in Eq. (1):
TAC it =TAit—1 ¼ a1 ð1=TAit—1 Þ þ a2 ððDSALESit =TAit—1 Þ — ðDARit =TAit—1 ÞÞ þ a3 ðPPEit =TAit—1 Þ þ eit ð1Þ
All variables are defined in the Appendix.
The second model to estimate the magnitude of earnings management is Kothari et al. (2005) performance adjusted
model defined in Eq. (2):
TAC it =TAit—1 ¼ a0 þ a1 ð1=TAit—1 Þ þ a2 ððDSALESit =TAit—1 Þ — ðDARit =TAit—1 ÞÞ þ a3 ðPPEit =TAit—1 Þ þ a4 ðROAit—1 Þ þ eit ð2Þ
Discretionary accruals in Eqs. (1) and (2) are determined by performing separate regressions for each Global Industry
Classification Standard (GICS) industry group with six or more observations in a single financial period. Given the nine GICS
industry groups and five financial years (2008–2012) covered by this study, a maximum of 45 separate cross-sectional
regressions are performed for each model.7
7
Traditionally, the ASX comprises ten GICS groups. Consistent with prior Australian studies on earnings management (Fargher et al., 2008), we exclude all
banking (ASX two-digit classification code 16), insurance (ASX two-digit classification code 17), investment (ASX two-digit classification code 19), and property
management (ASX two-digit classification code 20) industry groups within the financial sector, as these industry groups are subject to different disclosure
requirements that make estimating discretionary accruals problematic, and the total asset base and financial structure of such firms is not comparable to other
firms. Hence, only nine GICS groups are used.
In determining the level of discretionary accruals, a pivotal initial step is to calculate total accruals. We use the cash -flow
statement approach advocated in Collins and Hribar (2002) as defined in Eq. (3):
TAC it ¼ NIit — CFOit ð3Þ
As we focus on the magnitude rather than the direction of earnings management, the absolute value of the discretionary
accruals (denoted as |DACit|) is used as the dependent variable to formally test the proposed hypotheses. The magnitude of
unsigned discretionary accruals has been reported to be a good measure of the extent to which accruals have been used to
manage earnings in the absence of specific directional predictions (Francis et al., 1999). For the main tests, the absolute value
of residuals from Eq. (1) (MJ|DACit|) forms our first measure of earnings management, and the absolute value of residuals
from Eq. (2) (KOTHARI|DACit|) forms our second measure. We later partition the earnings management sample into firms with
positive (income-increasing) discretionary accruals versus those with negative (income-decreasing) discretionary accruals.
The main tests are then reperformed to investigate whether the external auditor variables are differentially related to pos-
itive and negative discretionary accruals.
4.2. Measurement of audit partner tenure and audit firm tenure
To comprehensively capture the influence of audit engagement partner tenure on aggressive earnings management prac -
tices, we focus on both continuous (PARTENUREit) and dichotomous (STENUREit) measures of partner tenure. PARTENUREit
denotes the number of consecutive years an audit partner has served as the signing partner on an engagement for client firm
i at time period t. For STENUREit, a client firm i in time period t is scored 1 if the audit partner has been its engagement partner
for two years or less (Carey and Simnett, 2006), and 0 otherwise.
The number of consecutive years of audit partner tenure (PARTENUREit) is interacted with auditor type (Big 4 versus non-
Big 4) to determine whether partner-tenure effects are stronger (weaker) for auditors from non-Big 4 (Big 4) firms. Short
partner tenure (STENUREit) is interacted with auditor NAS/abnormal NAS fees to examine whether the link between auditor
NAS/abnormal NAS fees and earnings management is contingent on the length of audit partner tenure.
While the primary purpose of this study is to examine the effect of audit partner tenure on audit quality, we also use audit
firm tenure (AUDTENUREit) as a control variable. AUDTENUREit denotes the number of consecutive years an incumbent audit
firm has served the client firm i at the end of time period t. For continued auditor–client relationships, we compute
AUDTENUREit from 1990, the year that DatAnalysis started providing this information.
4.3. Measurement of auditor NAS/abnormal NAS fees
Auditor NAS fees are captured using two continuous measures commonly used in empirical research, namely
RNONAUDITit, which represents the ratio of NAS fees to total fees paid to the audit firm by client firm i at the end of time
period t, and LNNASit, which represents the natural logarithm transformation of auditor NAS fees of client firm i at the
end of time period t (Habib, 2012). Following scholars such as Hossain (2013), we use the following ordinary least squares
(OLS) model linking actual fees with their determinants to calculate abnormal NAS fees (ABNONAUDITit) for each year sep-
arately. The abnormal NAS fees are the residuals of the following estimated model:
LNNASit ¼ b0 þ b1LNTAit þ b2BIG4it þ b3EQUITYit þ b4MERGACQSit þ b5ROAit þ b6LEVit þ b7NEG ROAit

X
þ b8 GROWTHit þ b9 MKTBK it þ b10 LNSUBSit þ b11 FOROPSit þ b12 USLIST it þ b13 INDUSTRY it þ eit ð4Þ

Following Hossain (2013), client firms without NAS fees during the period are substituted with 1 for logarithmic trans-
formation purposes.
4.4. Control variables
Our choice of control variables is informed by past literature. We control for Big 4 auditors (BIG4it) as they have been
found to more aggressively mitigate insider incentives for exploiting accounting-based contractual constraints and manag-
ing earnings (Gul et al., 2002), and have on average, been associated with lesser discretionary accruals (Becker et al., 1998).
We include audit firm tenure (AUDTENUREit) as past studies find longer audit firm tenure to be associated with lesser dis-
cretionary accruals (Myers et al., 2003). As the prior literature finds the presence of female audit engagement partners to
have a constraining effect on earnings management (Ittonen et al., 2013), we control for audit engagement partner gender
(FEMALEit).
We control for client firm size (LNMVEit) as larger firms have been associated with reporting lesser discretionary accruals
(Carey and Simnett, 2006; Hossain, 2013). Consistent with Carey and Simnett (2006) and Hossain (2013), we control for firm
age (AGEit) since accruals have been reported to differ with changes in firm life cycle. We include market to book ratio
(MKTBKit) and annual sales growth (SGRit) to control for differences in growth opportunities (Gopalan and Jayaraman,
2012). We control for firm performance using return on assets (ROAit) (Hossain, 2013) and reporting a loss (LOSSit)
(Gopalan and Jayaraman, 2012). Consistent with past studies (Carey and Simnett, 2006; Hossain, 2013), we also control for
leverage (LEVit) as highly leveraged firms have been reported to more likely manipulate accounting numbers. We control for
a firm’s capital intensity (CIRit), which has been shown to influence a firm’s ability to engage in earnings management
(Gopalan and Jayaraman, 2012). Lagged value of total accruals (TACit-1) is used as a control since past studies have found that
a majority of the mean reversions of accruals occur within a year (Dechow, 1994), and hence, it can been argued that a higher
(lower) levels of lagged total accruals will reduce (increase) a manager’s capacity to aggressively manage earnings upward in
the current year. We control for sales volatility (SDREVit) as it has been reported to be highly correlated with the magnitude
of discretionary accruals (Hribar and Nichols, 2007). Finally, we also include year dummies (YEARit) to control for fixed year
effects.
4.5. Models to examine the association between test variables and earnings management
We use pooled OLS multiple regression to analyze the relationship between the selected auditor attributes and earnings
management.
To test hypothesis H1a, H1b, H2a, and H2b we estimate the following OLS regression model:
EMit ¼ b0 þ b1FEEit þ b2PARTENUREit þ b3PARTENUREit m BIG4it þ b4BIG4it þ b5AUDTENUREit þ b6AGEit

þ b7FEMALEit þ b8LNMVEit þ b9MKTBKit þ b10SGRit þ b11LOSSit þ b12ROAit þ b13LEV it þ b14CIRit
X
þ b15 SDREV it þ b16 TAC it—1 þ b17 YEARit þ eit ð5Þ
To test hypotheses H3a and H3b we estimate the following OLS regression model:
EMit ¼ b0 þ b1FEEit þ b2STENURE it þ b3FEEit m STENUREit þ b4BIG4it þ b5AUDTENUREit þ b6AGEit þ b7FEMALEit

þ b8LNMVEit þ b9MKTBK it þ b10SGRit þ b11LOSSit þ b12ROAit þ b13LEVit þ b14CIRit þ b15SDREV it
X
þ b16 TAC it—1 þ b17 YEARit þ eit ð6Þ
The first set of regressions to test the hypotheses are performed by regressing the independent and control variables in
Eqs. (5) and (6) against the first earnings management proxy measure MJ|DACit|, the absolute value of discretionary accruals
measured using the modified Jones model. To confirm that the findings of this study are not dependent on the model used, a
second set of regressions are performed using the second earnings management proxy measure KOTHARI|DACit|, the absolute
value of discretionary accruals measured using the performance adjusted model. 8
For hypothesis H1a and H1b to be supported, we expect the coefficients on partner tenure (PARTENUREit) from Eq. (5) to be
negative and significantly associated with earnings management proxies (EMit) but coefficients on the interactions between
partner tenure and Big 4 auditors (PARTENUREit⁄ BIG4it) to be positive and significantly associated with EMit. Such interactions
between partner tenure and Big 4 auditors would indicate that the effect of partner tenure applies only to non -Big 4 audit
engagements. For hypothesis H2a and H2b, we expect non-audit and abnormal non-audit fee metrics (generically labelled
FEEit) to be insignificantly associated with EMit in Eq. (5). Finally, for hypothesis H3a and H3b, we expect the coefficients
on the interactions between non-audit/abnormal non-audit fee metrics and short audit partner tenure of 2 years or less
(FEEit⁄STENUREit) to be positive and significantly associated with EMit in Eq. (6).
5. Sample selection
Table 1 Panel A outlines the sample selection process. Our final usable sample consists of 250 firms per calendar year for
2008–2012. Initially, 125 firms were chosen because they were listed at the top of the ASX based on market capitalization in
2008, after which another 125 firms were randomly selected from the 501st firm onwards on the exchange.9 After obtaining
the final sample of 250 firms for 2008, the same firms were selected for 2009–2012, resulting in a total final sample of 1,250
firm-year observations.10
8
In our main tests, we report results for both the Dechow et al. (1995) modified Jones model as well as the Kothari et al. (2005) performance adjusted model.
In additional tests, for the sake of brevity, we only report results for the Kothari et al. (2005) performance adjusted model. The results obtained using the
modified Jones model are largely consistent with those of the performance adjusted model.
9
We adopt a stratified random sampling approach in which we initially select the first 125 firms from the top 500 ASX listed firms by market capitalization
(after necessary exclusions) to cover the largest proportion of ASX. The top 500 ASX listed firms have been reported to repre sent 95% of the total market
capitalization of all listed firms in Australia (Wang and Clift, 2009). However, although this increases the generalizability of our findings, selecting such firms
also introduces ‘‘substantial size bias” in our sample. In order to mitigate such size biases, we therefore randomly select t he remaining 125 firms outside of the
ASX 500 largest firms.
10
This sample selection process may result in possible survivorship bias concerns. To address this concern, we investigate the attrition of firms from our
sample for each year in our observation window. There were 1,335 firms listed on ASX in 2008 of which 11 firms were delisted during the 2008–2012 period.
This finding suggests that less than 1% of firms did not survive during the 2008–2012 period. Hence, survivorship bias issue arising from our selection of
continuously listed firms does not appear to be of concern in terms of adversely affecting our results.
Table 1
Sample Selection and Industry Breakdown.
Panel A: Sample Selection
Number of Firms Listed on the ASX as at 1 January 2008 2339

Exclusions:
Financial Institutions 369
Trusts & Investments 13
Firms with Missing Data and Firms not Continuously Listed 754
Foreign Incorporated Firms 30
Firms with Changed End of Financial Year Dates 18 (1184)
Sample Pool for Random Selection 1155
Top 125 Firms from Top 500 Firms by Market Capitalization 125
Random Selection of Remaining Firms from 501st Firm Onwards 125
Final Sample (2008) 250
Final Usable Sample (2008 – 2012) 250*5 1250
Panel B: Sample Firm Breakdown by Industry in 2008
Top 125 Firms Randomly Selected 125 Pooled Sample/Final

Firms Usable Sample – 250
Firms
ASX Industry No. of % of No. of % of No. of % of

Firms Sample Firms Sample Firms Sample
Consumer Discretionary 20 8.00 10 4.00 30 12.00
Consumer Staples 6 2.40 4 1.60 10 4.00
Energy 16 6.40 24 9.60 40 16.00
Health Care 11 4.40 17 6.80 28 11.20
Industrials 27 10.80 10 4.00 37 14.80
Information Technology 4 1.60 8 3.20 12 4.80
Materials 35 14.00 45 18.00 80 32.00
Telecommunication 2 0.80 4 1.60 6 2.40
Services
Utilities 4 1.60 3 1.20 7 2.80
Total 125 50.00 125 50.00 250 100.00
The sample period 2008–2012 is selected to reflect all CLERP 9 changes.11 CLERP 9 changes were fully effective from finan-
cial years beginning in July 2006 (Fargher et al., 2008). For example, the requirement of mandatory rotation of a signing audit
partner on an audit every five years or less followed by a two year cooling off period has been effective from 1 July 2006. Also
from 1 July 2006 auditing standards have the force of law for audits and reviews of Corporations Act entities under sections
307A/336 of the Corporations Act (2001). The ‘Corporations Legislation Amendment (Simpler Regulatory System) Act 2007’
which was granted the royal assent on 28 June 2007 signaled the completion of the ‘bedding down’ of the major auditor reg-
ulatory reforms introduced by CLERP 9 in 2004 (The Treasury, 2010). As such, analysis from 2007 initially appears to be an
appropriate starting point. However, prior Australian research shows that, in the post-CLERP 9 period, the peak audit partner
rotations occurred in 2007 (Chapple and Hossain, 2011). We have therefore refrained from examining audit quality during
the peak audit partner rotation period of 2007 due to the potential impact this may have on our results. Consequently, we com-
mence our study from 2008.
Table 1 Panel B presents the industry breakdown of the sample firms. The two most prominent industry sectors in the
sample, Materials (32%) and Energy (16%), jointly comprise 48% of the final sample in 2008, with Telecommunication Ser -
vices (2.40%) and Utilities (2.80%) being the least represented.
6. Data analyses and discussion
6.1. Descriptive statistics
Table 2 presents descriptive statistics on the full sample for the variables used in the main discretionary accrual models.
All continuous variables are winsorized at the 1 percent and the 99 percent levels.
The absolute values of discretionary accruals calculated using the modified Jones model (MJ|DACit|) have a mean (median)
of 0.145 (0.068) and a standard deviation of 0.221 and the absolute values of discretionary accruals calculated using the per -
formance adjusted model (KOTHARI|DACit|) have a mean (median) of 0.146 (0.075) and a standard deviation of 0.213. Such
values indicate that the average magnitude of earnings management is at around 15% of total assets for Australian listed
firms, which is comparable with prior Australian studies (Davidson et al., 2005). When disaggregating this into larger and
11
All the firm-years in our sample had sufficient data from fiscal years 2007–2012 to estimate accruals for our observation window (2008–2012); notably
2007 data for 2008 firm-year observations.
Table 2
Descriptive statistics.
Overall Sample (n = 1250) Sample Firms Sample Firms Audited Difference in

Audited by Big 4 by Non-Big 4 Auditors Means- Big 4 vs
Auditors (n = 757) (n = 493) Non-Big 4
Variable Mean Standard 25th Median 75th Mean Mean t-statistics
deviation percentile percentile
Dependent Variables
MJ|DACit| 0.145 0.221 0.027 0.068 0.169 0.105 0.205 —7.237***
KOTHARI|DACit| 0.146 0.213 0.034 0.075 0.168 0.107 0.207 —7.574***
Variables of Interest
AUDIT FEEit 793.488 1,633.136 46.539 168.631 798.500 1,244.779 100.532 15.908***
($’000)
NON-AUDIT FEEit 1,599.349 23,818.429 0.584 48.950 368.485 2,615.080 39.698 2.318**
($’000)
TOTAL FEEit 3,891.103 64,611.917 57.196 258.167 1,340.823 6,333.936 140.140 2.054**
($’000)
RNONAUDITit 0.247 0.223 0.008 0.211 0.446 0.305 0.158 12.426***
LNNASit 3.849 2.332 2.766 4.690 5.566 4.728 2.500 18.269***
ABNONAUDITit 0.002 1.593 —0.991 0.268 1.108 0.007 —0.005 0.120
PARTENUREit 2.640 1.354 1.000 2.000 4.000 2.690 2.560 1.597
BIG4it 0.606
Control and Other Variables

AUDTENUREit 7.740 5.719 3.000 6.000 11.000 9.140 5.600 11.888***
PARTENSWITCHit 0.254 0.251 0.258 — 0.409
AUDFIRMSWITCHit 0.063 0.048 0.087 —2.722***
AGEit 15.500 15.950 5.000 10.000 20.000 18.120 11.470 7.665***
FEMALEit 0.088 0.12 0.04 5.567***
MVEit ($’M) 3,144.189 16,182.900 14.917 220.241 1,551.768 4,969.921 340.782 6.157***
LNMVE it 8.213 1.165 7.174 8.343 9.191 8.788 7.329 28.281***
MKTBK it 2.340 2.688 0.820 1.505 2.833 2.449 2.174 1.770*
SGRit 6.339 48.543 —0.132 0.056 0.464 3.881 10.113 —2.022**
LOSSit 0.478 0.290 0.770 —19.475***
ROAit —0.101 0.382 —0.126 0.021 0.079 —0.005 —0.247 10.523***
LEVit 0.344 0.256 0.097 0.340 0.526 0.400 0.257 9.462 ***
CIRit 0.216 0.237 0.015 0.103 0.381 0.278 0.121 12.722***
SDREVit 7.043 69.474 0.009 0.086 0.198 11.504 0.192 3.496***
TACit-1 —0.105 0.366 —0.099 —0.036 —0.001 —0.066 —0.165 4.133***
*** ** *
, , denote significance at the 1%, 5% and 10% levels (two-tailed), respectively.
smaller firms, we find (untabulated) earnings management practices in smaller firms approximate 19% of total assets com -
pared to 9% of total assets by larger firms.
The mean NAS fee is $1,599,349 which is higher than the mean NAS fee documented in Hossain (2013). The ratio of NAS
fees to total fees (RNONAUDITit), the natural log of non-audit fees (LNNASit), and the abnormal NAS fees (ABNONAUDITit) have
a mean (median) of 0.247 (0.211), 3.849 (4.690), and 0.002 (0.268), respectively. On average, audit partner tenure
(PARTENUREit) is 2.6 years, while audit firm tenure (AUDTENUREit) is 7.7 years. In terms of actual auditor rotations in our
sample, 25.4% of the rotations related to audit partners (PARTENSWITCHit), while 6.3% related to audit firms
(AUDFIRMSWITCHit).
The Big 4 audit firms (BIG4it) audited 60.6% of the client observations in the sample, while female audit partners
(FEMALEit) signed off on only 8.8% of the client observations in the sample. Descriptive statistics for both the client firms
audited by Big 4 and non-Big 4 auditors are also provided in Table 2. On average, Big 4 client firms are found to have signif-
icantly lower discretionary accruals and pay significantly higher audit and non-audit fees. The length of partner tenure
between Big 4 and non-Big 4 audit clients is not found to be significantly different and this is consistent with the mandatory
partner rotation requirement.
6.2. Correlation matrix
Table 3 presents a correlation matrix reporting the Pearson correlation coefficients for both the continuous and dichoto-
mous variables. A review of the correlation matrix provides some support for hypothesis H1a, as absolute discretionary accru-
als (KOTHARI|DACit|) are found to be negatively correlated with the number of consecutive years an audit partner served as
signing partner on a client firm’s engagement (PARTENUREit). KOTHARI|DACit| is also found to be negatively correlated with
the length of audit firm tenure (AUDTENUREit). Some early support is also provided for hypothesis H2b, as KOTHARI|DACit| is
found to be insignificantly correlated with abnormal NAS fees (ABNONAUDITit).
A. Singh et al. / Journal of Contemporary Accounting and Economics 15 (2019) 186–205

Table 3
Pearson correlation coefficients.
Variables 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
1. KOTHARI|DACit| 1.00
2. RNONAUDITit —0.14*** 1.00
3. LNNASit —0.22*** 0.76*** 1.00
4. ABNONAUDITit 0.03 0.56*** 0.69*** 1.00
5. PARTENUREit —0.08*** —0.00 0.01 —0.01 1.00
6. BIG4it —0.23*** 0.32*** 0.47*** 0.00 0.05 1.00
7. AUDTENURE it —0.19*** 0.22*** 0.33*** 0.06** 0.11*** 0.30*** 1.00
8. AGEit —0.10*** 0.18*** 0.28*** 0.06** 0.05* 0.20*** 0.49*** 1.00
9. FEMALE it —0.04 0.03 0.04 0.02 0.01 0.14*** 0.03 0.05* 1.00
10. LNMVEit —0.25*** 0.42*** 0.61*** 0.00 0.05 0.61*** 0.38*** 0.35*** 0.00 1.00
11. MKTBKit 0.09*** 0.04 —0.01 —0.01 0.01 0.05* —0.04 —0.04 —0.01 0.17*** 1.00
12. SGRit 0.14*** 0.03 0.02 0.07** —0.02 —0.06** —0.04 —0.05* —0.04 0.01 —0.00 1.00
13. LOSSit 0.23*** —0.32*** —0.52*** —0.01 —0.05* —0.48*** —0.33*** —0.25*** —0.04 —0.66*** —0.01 0.02 1.00
14. ROAit —0.34*** 0.21*** 0.32*** 0.01 0.03 0.31*** 0.27*** 0.15*** 0.01 0.49*** —0.14*** —0.01 —0.54*** 1.00
15. LEVit —0.05* 0.21*** 0.41*** 0.03 0.00 0.27*** 0.14*** 0.72** —0.05* 0.35*** 0.08*** 0.04 —0.40*** 0.05* 1.00
16. CIRit —0.07*** 0.23*** 0.36*** 0.04 0.03 0.32*** 0.15*** 0.21*** —0.06** 0.46*** —0.01 0.10*** —0.32*** 0.18*** 0.41*** 1.00
17. SDREVit —0.03 0.10*** 0.07*** 0.00 —0.01 0.08*** —0.09*** —0.08*** —0.03 0.09*** —0.02 0.07** —0.10*** 0.05* 0.07** 0.08*** 1.00
18. TACit-1 —0.12*** 0.06** 0.14*** 0.02 0.02 0.13*** 0.17*** 0.13*** 0.04 0.14*** —0.05* —0.01 —0.15*** 0.18*** 0.00 0.04 —0.17*** 1.00
*** ** *
, ,denote significance at the 1%, 5% and 10% levels (two-tailed), respectively.
195
6.3. Multivariate main results
6.3.1. Individual effects of length of audit partner tenure and auditor NAS/abnormal NAS fees on audit quality
Table 4 summarizes the individual effects of length of audit partner tenure and auditor NAS/abnormal NAS fees on audit
quality (proxied by the absolute value of discretionary accruals). To mitigate misspecification issues and enhance the validi ty
and reliability of our results, two different variations of aggregate accruals are used to estimate discretionary accruals. Col -
umns 1–3 show the OLS results using the modified Jones model, and columns 4–6 show the results using the performance
adjusted model. Results tabulated in columns 1–3 are found to be largely consistent with those in columns 4–6, indicating that
the findings of this study are not dependent on the model used to measure discretionary accruals. The adjusted R 2s vary from
18.4% to 19% for columns 1–6 with an F-value significant at the 0.01 level.
In support of H1a, length of partner tenure (PARTENUREit) is found to be negatively associated (p < 0.01) with discretionary
accruals, showing that longer audit partner tenure is linked to lower earnings management. However, the significant inter-
actions between PARTENUREit and Big 4 auditors (BIG4it) indicate that this effect applies primarily to non-Big 4 engagements.
The coefficients of PARTENUREit and BIG4it remain significantly negative (p < 0.01) while the coefficients on the interaction
term PARTENUREit⁄BIG4it remain significantly positive (p < 0.05) across all six regression specifications. These results fully
support H1b, showing that Big 4 auditors are significantly more proficient at constraining earnings management during
Table 4
Individual effects of non-audit fees and partner tenure on earnings management.
Variables (MJ|DACit|) (KOTHARI|DACit|)
Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic) (t-statistic) (t-statistic)
Intercept 0.398 0.370 0.394 0.425 0.406 0.417

(5.694***) (5.272***) (5.696***) (6.313***) (5.993***) (6.258*** )
RNONAUDITit 0.014 0.021
(0.429) (0.693)
LNNASit —0.006 —0.003
(—1.522) (—1.037)
ABNONAUDITit 0.001 0.002
(0.169) (0.697)
PARTENUREit —0.020 —0.020 —0.020 —0.017 —0.017 —0.017
*** *** *** *** ***
(—2.931***) (—3.014 ) (—2.947 ) (—2.658 ) (—2.713 ) (—2.655 )
PARTENUREit* BIG4it 0.017 0.018 0.018 0.017 0.017 0.017
(2.027**) (2.098**) (2.041**) (2.015**) (2.064**) (2.016** )
BIG4it —0.089 —0.087 —0.089 —0.079 —0.078 —0.079
*** *** *** *** ***
(—3.317***) (—3.268 ) (—3.313 ) (—3.083 ) (—3.047 ) (—3.058 )
AUDTENUREit —0.001 —0.001 —0.001 —0.002 —0.002 —0.002
(—0.935) (—0.797) (—0.902) (—1.524) (—1.419) (—1.513)
AGEit 0.000 0.000 0.000 0.000 0.000 0.000
(0.427) (0.537) (0.445) (0.967) (1.038) (0.952)
FEMALEit —0.009 —0.007 —0.009 —0.008 —0.007 —0.008
(—0.432) (—0.358) (—0.424) (—0.408) (—0.361) (—0.412)
LNMVEit —0.019 —0.013 —0.018 —0.021 —0.017 —0.020
** ** ** **
(—2.157**) (—1.411) (—2.119 ) (—2.572 ) (—2.021 ) (—2.452 )
MKTBK it 0.003 0.003 0.003 0.004 0.004 0.004
(1.344) (1.134) (1.345) (1.829* ) (1.706* ) (1.823* )
SGRit 0.001 0.001 0.001 0.001 0.001 0.001
(4.560***) (4.660***) (4.584***) (4.631***) (4.704***) (4.608*** )
LOSSit —0.015 —0.019 —0.015 —0.015 —0.017 —0.015
(—0.901) (—1.106) (—0.914) (—0.904) (—1.030) (—0.931)
ROAit —0.169 —0.169 —0.169 —0.155 —0.154 —0.155
*** *** *** *** ***
(—8.771***) (—8.768 ) (—8.761 ) (—8.330 ) (—8.314 ) (—8.321 )
LEVit 0.003 0.014 0.003 0.012 0.006 0.012
(0.101) (0.503) (0.119) (0.467) (0.219) (0.462)
CIRit 0.087 0.088 0.087 0.039 0.040 0.039
(3.016***) (3.043***) (3.021***) (1.422) (1.437) (1.404)
SDREVit 0.000 —0.000 —0.000 —0.000 —0.000 —0.000
(—1.132) (—1.047) (—1.099) (—0.956) (—0.873) (—0.910)
TACit-1 —0.034 —0.033 —0.034 —0.020 —0.019 —0.020
** **
(—2.071**) (—2.019 ) (—2.079 ) (—1.250) (—1.232) (—1.277)
YEARit Included Included Included Included Included Included
Adjusted R2 0.188 0.190 0.188 0.184 0.184 0.184
F statistic (sig.) 15.470*** 15.680*** 15.460*** 15.080*** 15.110*** 15.080***
Observations 1250 1250 1250 1250 1250 1250
*** ** *
the initial period of an audit engagement, whereas non-Big 4 auditors require the learning experience obtained through
longer partner tenure to constrain earnings management and improve audit quality.
The results in columns 1, 2, 4 and 5 indicate that neither measure of auditor NAS fees, RNONAUDITit and LNNASit, is sig-
nificantly associated with either measure of earnings management. A similar result is found in columns 3 and 6 for abnormal
NAS fees calculated using Eq. (4), suggesting that abnormal NAS fees do not make auditors more tolerant of higher accruals
through economic dependence on clients. Hence, both hypotheses H2a and H2b are fully supported.
6.3.2. Joint effects of length of audit partner tenure and auditor NAS/abnormal NAS fees on audit quality
Table 5 reports the effects of length of partner tenure on the association between auditor NAS/abnormal NAS fees and
audit quality, assessed by including an interaction term for each fee metric and length of partner tenure. Consistent with
prior literature (for example, Carey and Simnett, 2006; Fargher et al., 2008), we split the sample into short and medium
tenure based on a two year cut-off, and code short tenure of two years or less (STENUREit) as 1. The insignificant coefficients in
columns 1, 2, 4, and 5 suggest that the effect of auditor NAS fees on earnings management is not contingent on the length
Table 5
Joint effects of non-audit fees and short partner tenure on earnings management.
Variables (MJ|DACit|) (KOTHARI|DACit|)

Intercept 0.345 0.314 0.334 0.382 0.364 0.363
(5.012***) (4.505***) (4.926***) (5.758***) (5.423***) (5.566***)
RNONAUDIT it 0.011 0.012
(0.267) (0.311)
RNONAUDIT it*STENUREit 0.012 0.022
(0.238) (0.444)
LNNAS it —0.004 —0.004
(—0.872) (—1.065)
*
LNNAS it STENUREit —0.000 —0.002
(—0.093) (—0.500)
ABNONAUDITit —0.008 —0.007
(—1.480) (—1.489)
*
ABNONAUDITit STENUREit 0.014 0.019
(1.971**) (2.799*** )
STENUREit 0.008 0.013 0.012 0.001 0.002 0.007
(0.497) (0.618) (1.028) (0.087) (0.089) (0.636)
BIG4it —0.035 —0.033 —0.035 —0.037 —0.035 —0.037
(—2.248**) (—2.140**) (—2.257**) (—2.516**) (—2.374**) (—2.526**)
AUDTENUREit —0.001 —0.001 —0.001 —0.002 —0.002 —0.002
* *
(—1.193) (—1.081) (—1.168) (—1.648 ) (—1.544) (—1.650 )
AGEit —0.000 —0.000 —0.000 0.000 0.000 0.000
(—0.469) (—0.379) (—0.448) (1.002) (1.071) (1.013)
FEMALEit —0.009 —0.008 —0.006 —0.008 —0.006 —0.004
(—0.436) (—0.389) (—0.302) (—0.385) (—0.320) (—0.222)
LNMVEit —0.022 —0.018 —0.021 —0.021 (— —0.017 (— —0.019
(—2.531**) (—1.959**) (—2.425**) 2.556**) 2.030**) (—2.359**)
MKTBK it 0.002 0.002 0.002 0.004 0.004 0.004
(0.783) (0.649) (0.790) (1.808*) (1.695*) (1.821*)
SGRit 0.000 0.000 0.000 0.001 0.001 0.001
(3.969***) (4.053***) (3.973***) (4.654***) (4.719***) (4.617***)
LOSSit —0.035 —0.036 —0.035 —0.015 —0.017 —0.016
** **
(—1.934*) (—2.005 ) (—1.958 ) (—0.924) (—1.055) (—0.975)
ROAit —0.158 —0.158 —0.158 —0.153 —0.153 —0.154
(—8.183***) (—8.186***) (—8.227***) (—8.230***) (—8.220***) (—8.299***)
LEVit 0.075 0.080 0.078 0.011 0.005 0.008
(2.586***) (2.727***) (2.678***) (0.429) (0.192) (0.326)
CIRit 0.075 0.077 0.076 0.040 0.040 0.039
(2.526**) (2.568***) (2.537**) (1.421) (1.424) (1.399)
SDREVit —0.000 —0.000 —0.000 —0.000 —0.000 —0.000
(—0.806) (—0.735) (—0.769) (—1.001) (—0.898) (—0.938)
TACit-1 —0.026 —0.026 —0.026 —0.019 —0.019 —0.018
(—1.618) (—1.611) (—1.593) (—1.193) (—1.183) (—1.179)
YEARit Included Included Included Included Included Included
Adjusted R2 0.183 0.185 0.185 0.180 0.180 0.185
F statistic (sig.) 14.980*** 15.160*** 15.160*** 14.670*** 14.700*** 15.150***
Observations 1250 1250 1250 1250 1250 1250
*** ** *
of audit partner tenure, thus rejecting hypothesis H3a. However, whereas columns 3 and 6 show insignificant negative coef-
ficients for abnormal NAS fees, the interaction between abnormal NAS fees and short partner tenure is significantly positive
(p < 0.05 for MJ|DACit|; p < 0.01 for KOTHARI|DACit|). These results suggest that abnormal NAS fees are linked to earnings man-
agement when audit partner tenure is short, but not when tenure is of medium length.12 Thus, hypothesis H3b is supported.
We also compare audit quality when audit partners are rotated versus when audit firms are rotated. Consistent with
Fargher et al. (2008), we re-run Eq. (6) after replacing STENUREit with PARTENSHORTSAMEit and PARTENSHORTDIFFit, where
PARTENSHORTSAMEit is an indicator variable which is scored 1 if STENUREit is 1 and the new partner is from the same firm
as the outgoing partner and 0 otherwise; while PARTENSHORTDIFFit is scored 1 if STENUREit is 1 and the new partner is
from a different firm as the outgoing partner and 0 otherwise. The results (not tabulated) show the coefficient on
ABNONAUDITit⁄PARTENSHORTSAMEit to be positive and significant for the performance adjusted model (t = 2.409; p < 0.05)
while the coefficient on ABNONAUDITit⁄PARTENSHORTDIFFit to be positive but insignificant. The results indicate that our
finding on the association between abnormal NAS fees and earnings management for short partner tenure is driven by
firm-years where incoming partner is from the same firm as the outgoing partner.
6.4. Alternative measures of audit quality
We also examine the association between NAS fees, abnormal NAS fees, length of audit partner tenure, and issuance of
going-concern opinions. The sample for the audit opinion model is restricted to financially distressed companies only
(Carey and Simnett, 2006; Hossain, 2013). Financially distressed companies were identified based on either the company
reporting a loss or a negative cash flow from operations during a given year. The final sample consists of 635 firm-year obser-
vations for the audit opinion model.
The following logistic regression model is estimated to test whether NAS/abnormal NAS fee metrics are negatively linked
to audit quality when partner tenure is short in support of our findings reported in Table 5:
OPINIONit ¼ b0 þ b1FEEit þ b2FEEit m STENUREit þ b3STENUREit þ b4BIG4it þ b5AUDTENUREit þ b6LOPINION it

X
þ b7 AGEit þ b8 FEMALEit þ b9 LNMVEit þ b10 LLOSSit þ b11 ROAit þ b12 LEV it þ b13 YEARit þ eit ð7Þ
All variables are defined in the Appendix.13

Table 6 reports the effects of length of partner tenure on the association between auditor NAS/abnormal NAS fees and the
auditor’s propensity to issue a going-concern opinion (OPINIONit), assessed by including an interaction term for each fee met-
ric and length of partner tenure. Column 2 reports the coefficient on LNNASit to be positive but insignificant while the coef-
ficient on LNNASit⁄STENUREit to be negative and significant (p < 0.05). Column 3 reports the coefficient on ABNONAUDITit to be
positive but insignificant while the coefficient on ABNONAUDITit ⁄STENUREit to be negative and significant (p < 0.05). These
findings indicate that NAS/abnormal NAS fee metrics result in a lower likelihood of an auditor issuing a going-concern opin-
ion for a financially distressed firm when audit partner tenure is short. This evidence of reduced audit quality associated with
NAS/abnormal NAS fee metrics contingent on audit partner tenure supports our findings reported in Table 5.14
6.5. Alternative measures of abnormal NAS fees
To demonstrate the robustness of estimation of abnormal NAS fees, we recalculate abnormal NAS fees following the
approach by Choi et al. (2010) as the difference between estimated and actual NAS fees and re-run Eqs. (5) and (6). Consis-
tent with the main findings in Tables 4 and 5, results (not tabulated) show abnormal NAS fees to be positively associated with
earnings management when partner tenure is short (t = 2.526, p < 0.05). We also exclude ‘zero NAS’ observations and re-
run Eq. (6). 306 firm-year observations are dropped. Results (not tabulated) are consistent with main analyses. The
coefficient on ABNONAUDITit⁄STENUREit is positive and significant (t = 3.716, p < 0.01), while the coefficient on
ABNONAUDITit is insignificant (t = 0.611, p = 0.541).
6.6. Partitioning by signed earnings management
In the main analyses, this study uses the absolute value of discretionary accruals as a measure of audit quality, which
captures the combined effect of income-increasing and income-decreasing discretionary accruals, and reflects on the mag-
12
We undertake further analysis to determine whether different audit partner tenure cut-off points affect our main results. We re-run Eq. (6) after replacing
STENUREit with STENURE1it and STENURE3it, where STENURE1it is an indicator variable which is scored 1 if the audit partner is an engagement partner on the
client firm for a period of one year and 0 otherwise, while STENURE3it is scored 1 if the audit partner is an engagement partner on the client firm for a period of
less than or equal to three years and 0 otherwise. The results of a one year cut -off are similar to those of the two year cut-off reported in Table 5 but we do not
find any significant effect on earnings management when short partner tenure is based on a three year cut-off. We therefore conclude that abnormal NAS fees
are significantly associated with earnings management only for audit partner tenure of up to two years.
13
Our choice of control variables for the audit opinion model is informed by past literature (Carey and Simnett, 2006; Hossain, 2013).
14
We also compare the impact of NAS/abnormal NAS fee metrics on OPINIONit for short audit partner tenure resulting from audit partner rotations versus
audit firm rotations and find that our results on the association between NAS/abnormal NAS fees and reduced propensity of issuing a going-concern opinion to
financially distressed firms for short partner tenure are driven by firm-years where incoming partner is from the same firm as the outgoing partner.
Table 6
Joint effects of non-audit fees and short partner tenure on the issuance of going concern opinions.
Variables OPINIONit
Column 1 Column 2 Column 3

Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic)
Intercept 2.514 2.252 2.702
(1.781* ) (1.576) (1.921* )
RNONAUDIT it —0.005
(—0.006)
*
RNONAUDITit STENUREit —0.839
(—0.677)
LNNASit 0.089
(1.099)
LNNAS *STENURE —0.234
it it
(—2.228**)
ABNONAUDITit 0.137
(1.498)
ABNONAUDIT it*STENUREit —0.309
**
(—2.469 )
STENUREit —0.001 0.435 —0.141
(—0.004) (1.273) (—0.604)
BIG4it —0.136 —0.148 —0.163
(—0.496) (—0.537) (—0.589)
AUDTENUREit —0.002 —0.001 0.001
(—0.070) (—0.033) (0.021)
LOPINIONit 1.957 1.979 1.978
(7.602***) (7.624*** ) (7.624*** )
AGEit 0.011 0.012 0.011
(0.818) (0.832) (0.757)
FEMALEit 0.205 0.205 0.140
(0.459) (0.458) (0.312)
LNMVEit —0.696 —0.697 —0.725
*** ***
(—3.806***) (—3.759 ) (—4.059 )
LLOSSit 0.445 0.484 0.468
(1.073) (1.161) (1.125)
ROAit —0.854 —0.850 —0.841
*** ***
(—3.200***) (—3.182 ) (—3.158 )
LEVit 2.163 2.206 2.119
(4.837***) (4.677*** ) (4.686*** )
YEARit Included Included Included
Pseudo R2 0.301 0.307 0.308
LR v2 (16) (sig.) 213.460*** 217.880*** 218.950***
Observations 635 635 635
*** ** *
nitude of and dispersion in accruals (Hossain, 2013; Myers et al., 2003). Scholars such as Ashbaugh-Skaife et al. (2003) argue
that since earnings overstatements are likely to be associated with aggressive and opportunistic earnings management,
income increasing discretionary accruals are more frequent and of greater concern to auditors. Thus, we re-run Eqs. (5)
and (6) separately on observations with positive or income-increasing discretionary accruals (KOTHARIDACit+) and negative
or income-decreasing discretionary accruals (KOTHARIDAC-it ) to examine the impact of length of partner tenure and
NAS/abnormal NAS fee metrics on signed earnings management.
Regression results using KOTHARIDAC+ and KOTHARIDAC- are reported in Table 7. For the sample of KOTHARIDAC+, results
it it it
are found to be consistent with those reported in Tables 4 and 5. In Panel A, the coefficients on PARTENUREit and BIG4it are
found to be negative and significant (p < 0.01) while the coefficients on PARTENUREit⁄BIG4it are found to be positive and sig-
nificant (p < 0.01). As in our primary analyses, the length of partner tenure is significantly negative associated with incom e-
increasing earnings management and the effect of partner tenure applies primarily to non-Big 4 engagements. While Big 4
auditors are found to be significantly more proficient in constraining the income-increasing earnings management during
the initial period of an audit engagement, non-Big 4 auditors require the learning obtained through longer partner tenure
to constrain this aggressive type of earnings management and improve audit quality. The coefficient on ABNONAUDITit is
found to positive and marginally significant (p < 0.10), showing positive association between abnormal NAS fees and
income-increasing earnings management. In Panel B, the coefficient on ABNONAUDITit⁄STENUREit is reported to be positive
and significant (p < 0.05), indicating a strong positive association between abnormal NAS fees and income-increasing earn-
ings management for short partner tenure.
Table 7
Partitioning tests based on signed earnings management.
Panel A: Individual Effects of Non-Audit Fees and Partner Tenure on Signed Earnings Management
Variables KOTHARI DACit+ KOTHARI DACit-

Intercept 0.196 (2.050**) 0.202 (2.096**) 0.187 (1.957* ) —0.445 —0.418 —0.441
*** ***
(—6.936***) (—6.482 ) (—6.971 )
RNONAUDITit 0.037 (0.868) —0.011
(—0.394) *
LNNASit 0.004 (0.798) 0.006 (1.731 )
ABNONAUDITit 0.009 (1.886*) 0.001 (0.231)
PARTENUREit —0.032 —0.032 —0.031 0.002 (0.325) 0.002 (0.392) 0.002 (0.334)
*** ***
(—3.504***) (—3.510 ) (—3.464 )
PARTENUREit*BIG4it 0.036 0.036 0.036 —0.000 —0.001 —0.000
(3.048***) (3.088***) (3.093***) (—0.028) (—0.107) (—0.037)
BIG4it —0.129 —0.129 —0.127 0.023(0.912) 0.022(0.864) 0.023 (0.907)
*** ***
(—3.640***) (—3.656 ) (—3.612 )
AUDTENUREit —0.003 —0.002 —0.003 0.001(0.822) 0.001(0.741) 0.001 (0.806)
(—1.404) (—1.375) (—1.489)
OTHER CONTROL VARIABLES (INCLUDED Included Included Included Included Included Included
IN Table 4)
YEAR it Included Included Included Included Included Included
Adjusted R2 0.395 0.395 0.398 0.102 0.105 0.101
F statistic (sig.) 16.800*** 16.790*** 17.040*** 5.310*** 5.470*** 5.300***
Observations 486 486 486 764 764 764
Panel B: Joint Effects of Non-Audit Fees and Short Partner Tenure on Signed Earnings Management
Variables KOTHARI DACit+ KOTHARI DACit-

Intercept 0.096 1.016) 0.100 (1.052) 0.076 (0.816) —0.442 —0.417 —0.435
*** *** ***
(—7.035 ) (—6.574 ) (—7.055 )
RNONAUDITit 0.042 (0.760) —0.008
(—0.218)
*
RNONAUDITit STENUREit 0.005 (0.070) —0.008
(—0.170)
*
LNNASit 0.004 (0.744) 0.007 (1.717 )
LNNAS it*STENUREit —0.000 —0.002
(—0.075) (—0.519)
ABNONAUDITit —0.001 0.004 (0.825)
(—0.188)
* **
ABNONAUDITit STENUREit 0.021 (2.197 ) —0.001
(—0.911)
STENUREit 0.021 (0.893) 0.023 (0.790) 0.022 (1.449) 0.007 (0.454) 0.014 (0.687) 0.005(0.522)
BIG4it —0.040 —0.039 —0.038 0.023 (1.584) 0.020 (1.385) 0.023 (1.583)
* *
(—1.954*) (—1.928 ) (—1.870 )
AUDTENUREit —0.003 —0.003 —0.003 0.001 (0.898) 0.001 (0.826) 0.001 (0.866)
(—1.465) (—1.411) (—1.640)
OTHER CONTROL VARIABLES (INCLUDED Included Included Included Included Included Included
IN Table 5)
YEAR it Included Included Included Included Included Included
Adjusted R2 0.381 0.380 0.391 0.101 0.105 0.102
F statistic (sig.) 15.900*** 15.880*** 16.540*** 5.310*** 5.490*** 5.350***
Observations 486 486 486 764 764 764
*** ** *
For the sample of KOTHARIDAC- , Panel A reports the coefficients on PARTENURE and BIG4 to be insignificant. The coef-
it it it
ficient on LNNASit is reported to positive and marginally significant (p < 0.10), suggesting NAS fees to be associated with
income-decreasing earnings management. Panel B shows this result to be driven by partner tenure of 3 years and more.
6.7. Endogeneity
A major concern in examining the effects of audit partner tenure on earnings management is that the relationship
between audit partner tenure and audit quality may be subject to endogeneity arising from self-selection bias. Specifically,
unobservable time-variant and time-invariant factors may be correlated with both earnings management and audit partner
tenure and to address these issues, we perform Heckman’s (1979) two-stage estimation procedure. Specifically, we use
Heckman’s (1979) two-stage estimation procedure where the first stage includes a regression of key determinants of audit
partner tenure such as audit fees, Big4, NAS, audit firm tenure, loss, firm performance, financially distressed firms, leverage,
Table 8
Heckman’s two-stage estimation results.
Variables Stage One Stage Two
PARTENUREit (KOTHARI|DAC it|)
Column 1 Column 2
Coefficient Coefficient
(t-statistic) (t-statistic)
Intercept 2.559
(7.294***)
LNAUDIT FEEit —0.042
(—2.784***)
BIG4it —0.066
(—2.212**)
LNNASit —0.024
(—3.352***)
AUDTENUREit 0.025
(3.518***)
LOSSit —0.033
(—1.827**)
ROAit —0.006
(—1.920**)
DISTRESSit —0.061
(—1.410*)
MKTBKit 0.005
(1.025)
LEVit —0.059
(—0.985)
AGEit 0.000
(0.952)
BIG4it —0.037
(—2.536***)
RNONAUDITit —0.034
(—1.246)
AUDTENUREit —0.003
(—2.618**)
PARTENUREit —0.008
(—2.068**)
FEMALEit —0.011
(—0.571)
LNMVEit —0.016
(—1.944**)
MKTBKit 0.006
(2.537***)
SGRit 0.001
(4.855***)
LOSSit —0.015
(—0.936)
ROAit —0.146
(—7.863***)
LEVit —0.009
(—0.352)
CIRit 0.034
(1.214)
SDREVit —0.000
(—0.587)
LAMBDA 0.193
(5.627***)
INDUSTRYit Included Included
YEARit Included Included
Adjusted R2 0.236 0.248
F statistic (sig.) 14.458*** 13.326***
Observations 1250 1250
*** ** *
, , denote significance at the 1%, 5% and 10% levels (two-tailed), respectively.
and market to book ratio (Stefaniak et al., 2009). The results for the first-stage regression to predict audit partner tenure are
presented in Table 8 Column 1. The first stage regression results show that almost all of the variables (i.e., LNAUDIT FEEit,
BIG4it, LNNASit, AUDTENUREit, LOSSit, ROAit, and DISTRESSit) are significantly associated with audit partner tenure.
From the results of this first stage regression, we calculate an inverse Mills ratio (i.e., LAMBDA) and subsequently include
this ratio in our second stage regression to control for self-selection bias. Table 8 Column 2 reports the second stage regres-
sion results of the two-stage procedure (i.e., after controlling for LAMBDA). In the regression results reported, we find that the
coefficient on audit partner tenure remains negative and significant as predicted, confirming our main findings in Table 4.15
These results therefore suggest that endogeneity arising from self-selection bias issues is not likely to be driving our main
results.
6.8. Additional analyses
We undertake a number of additional analyses. First, to further validate our test results, we re-run our analyses using
industry fixed-effects and we find that our results are quantitatively similar. Second, to address the issue of clustering
(non-independence) in our sample, we re-run Eqs. (5) and (6) after clustering observations using robust standard errors cor-
rected for firm-level clustering and heteroscedasticity, consistent with prior research (Petersen, 2009). Results are consistent
with our main tests reported in Tables 4 and 5. Third, volatility in capital markets that arose from the global financial crisis in
July 2007 with the sub-prime crisis and the collapse of the US housing bubble was reported to produce a severe global eco-
nomic recession in 2007 and 2008 (Brunnermeier, 2009). To test whether the year 2008 is influencing our results, we re-run
Eqs. (5) and (6) after excluding 2008 firm-year observations. The results are found to be consistent with those reported in
Tables 4 and 5. Therefore, 2008 does not influence our results. To further check whether the results of our main tests
reported in Tables 4 and 5 are sensitive to time period, we estimate Eqs. (5) and (6) for each sample year, 2008–2012,
and find that the results remain consistent.
Finally, we use market capitalization to partition our sample into large and small client firms and repeat the m ain anal-
yses reported in Tables 4 and 5. In our sample, Big 4 auditors audit 566 of the 625 (90.6%) larger clients and 191 of the 625
(30.6%) smaller clients. The results (not tabulated) show coefficients on partner tenure to be negative and significant (p
< 0.05) for smaller clients (a majority of which are audited by non-Big 4 auditors). Coefficients on audit partner tenure are
not found to be significantly associated with earnings management for larger clients, which are largely audited by Big 4
auditors. These results support our earlier findings that client firms of non-Big 4 auditors with longer audit partner tenure
have lesser earnings management. Results (not tabulated) also report abnormal NAS fees to be positively associated with
earnings management for both larger clients (t = 3.096, p < 0.01) and smaller clients (t = 2.032, p < 0.05) when audit partner
tenure is short. Thus, regardless of client firm size, abnormal NAS fees are found to be positively associated with earnings
management for short partner tenure.
7. Conclusion
We extend prior research by providing evidence, for the first time, on the individual and joint effects of auditor NAS/
abnormal NAS fees and length of audit partner tenure on audit quality after the passage of CLERP 9. Prior studies have exam-
ined only individual effects of auditor provided NAS/abnormal NAS fees and length of audit engagement partner tenure on
auditor independence and audit quality in the pre-CLERP 9 period. We integrate two strands of audit literature to examine
whether the linkage between NAS/abnormal NAS fees and audit quality is contingent on audit engagement partner tenure.
We focus on the post-CLERP 9 period in our study particularly given we examine non-audit services and audit partner rota-
tion; both of which have had legislative impact from the passage of CLERP 9. Our investigation provides an understanding of
the effects from CLERP 9 changes on important monitoring mechanisms such as external auditing in enhancing the credibil-
ity of financial reporting. We argue that an investigation of NAS/abnormal NAS fees and audit quality without the consider -
ation of audit partner tenure is likely to provide an incomplete or biased picture.
Our results show that Big 4 auditors and the length of audit partner tenure are effective deterrents for earnings manage -
ment, specifically for income-increasing earnings management. Compared to Big 4 auditors, non-Big 4 auditors are associ-
ated with significantly higher levels of discretionary accruals. Learning experiences from longer partner tenure are critical for
non-Big 4 auditors to reduce managerial opportunism and enhance audit quality. Our findings raise concerns about the ‘‘one
size fits all” requirement for mandatory audit partner rotation imposed by CLERP 9. This provides an opportunity for regu -
lators to consider the possibility of applying partner rotation requirements differentially to clients of auditors; for examp le,
Big 4 compared to non-Big 4 audit firms.
We also find that for short partner tenure, abnormal NAS fees are positively associated with earnings management while
NAS/abnormal NAS fees are negatively associated with the issuance of going-concern opinions to financially distressed firms.
Results suggesting a negative association between NAS/abnormal NAS fees and audit quality when audit partner tenure is
short are driven by firm-years where the incoming partner is from the same firm as the outgoing partner. The economic bond
15
Given that non-audit services may also suffer from similar econometric issues such as those relating to audit partner tenure, we also undertake (but do not
tabulate) similar analyses for non-audit services and our results remain consistent with main analyses.
created because of the audit firm’s receiving of high NAS fees may make the incoming partner reluctant to disagree with
management’s interpretation of accounting matters. Also, an audit partner’s unfamiliarity with the client’s operations, pro -
cesses, and systems may contribute to this reduced audit quality in the early years of partner tenure.
Acknowledgements
The authors thank Zoltan Matolcsy (Co-Editor) and an anonymous reviewer for their constructive suggestions in improv-
ing the paper. We also thank Roger Simnett and Stephen Taylor for their comments and gratefully acknowledge the bene-
ficial remarks from both the discussant and participants at the British Accounting and Finance Association 2016
conference and the Accounting and Finance Association of Australia and New Zealand 2015 conference.
Appendix A
Appendix
Appendix
Variables Used in the Measurement of Earnings Management

TACit = total accruals of firm i for time period t;
NIit = earnings before extraordinary items and discontinued operations of firm i in year t;
CFOit = net cash flow from operating activities (taken directly from the statement of cash flows) of firm i in year t;
TAit-1 = total assets of firm i at the end of time period t-1;
DSALESit = the change in net sales of firm i between time period t-1 and time period t;
DARit = the change in accounts receivable of firm i between time period t-1 and time period t;
PPEit = the gross book value of the property, plant, and equipment of firm i at the end of time period t;
ROAit-1 = the rate of return on assets of firm i for time period t-1;
a = the coefficients of independent and control variables 0 through 4; and
eit = the error term representing the discretionary accruals of firm i for time period t.
Variables Used in the Measurement of Abnormal NAS Fees
LNNAS it = the natural logarithmic transformation of auditor provided non-audit services fees of client firm i at the end of time
period t;
LNTAit = the natural logarithmic transformation of total assets of firm i at the end of time period t;
BIG4it = client firm i in time period t is scored one (1) if the incumbent auditor j in time period t is a Big 4 audit firm, and zero
(0) otherwise;
EQUITYit = client firm i in time period t is scored one (1) if it issued new shares in time period t, and zero (0) otherwise;
MERGACQSit = client firm i in time period t is scored one (1) if it underwent a merger or an acquisition in time period t, and zero (0)
otherwise;
ROAit = the rate of return on assets of firm i for time period t, calculated as earnings before interest and tax divided by total
assets;
LEVit = the ratio of total debt to total assets of firm i at the end of time period t;
NEG_ROAit = client firm i in time period t is scored one (1) if it reports a negative return on assets in time period t, and zero (0)
otherwise;
GROWTHit = the change of assets of client firm i from time period t-1 to time period t;
MKTBKit = market to book ratio, measured as the ratio of total market capitalization of firm i at the end of time period t to the
total book value of assets of firm i at the end of time period t;
LNSUBS it = the natural logarithmic transformation of the number of subsidiaries of client firm i at the end of time period t;
FOROPS it = client firm i in time period t is scored one (1) if it has any foreign subsidiaries at the end of time period t, and zero (0)
otherwise;
USLISTit = client firm i in time period t is scored one (1) if it is cross-listed in the US at the end of time period t, and zero (0)
otherwise;
INDUSTRYit = an industry indicator variable to control for industry effects;
b = the coefficients of independent and control variables 0 through 13; and
eit = the error term.
Variables Used in the Main and Additional Tests
EMit = earnings management measures (MJ|DACit|, KOTHARI|DACit|);
MJ|DACit| = absolute value of discretionary accruals of firm i for time period t calculated using the cross-sectional version of the
modified Jones model introduced by Dechow et al. (1995);
KOTHARI|DAC it| = absolute value of discretionary accruals of firm i for time period t calculated using the performance adjusted model
introduced by Kothari et al. (2005);
KOTHARI DAC it+ = positive (income-increasing) discretionary accruals calculated using the performance adjusted model introduced by
Kothari et al. (2005);
KOTHARI DACit- = negative (income-decreasing) discretionary accruals calculated using the performance adjusted model introduced by
Kothari et al. (2005);
OPINIONit = client firm i in time period t is scored one (1) if the financially distressed firm is issued a going-concern opinion by the
auditor, and zero (0) otherwise;
AUDIT FEEit = total audit fees in thousand dollars paid by client firm i in time period t;
(continued on next page)

LNAUDIT FEEit = natural Logarithmic transformation of the total audit fees in thousand dollars paid by client firm i in time period t;
NON-AUDIT FEEit = total auditor provided non-audit services fees in thousand dollars paid by client firm i in time period t;
TOTAL FEEit = total audit and non-audit services fees in thousand dollars paid by client firm i in time period t;
FEEit = alternative measures of non-audit services fees (RNONAUDITit, LNNASit, ABNONAUDITit);
RNONAUDITit = the ratio of non-audit fees to total fees paid to the audit firm by the client firm i in time period t;
LNNASit = natural log of non-audit services fees paid to the audit firm by the client firm i in time period t;
ABNONAUDITit = abnormal non-audit services fees paid to the audit firm by the client firm i in time period t;
PARTENUREit = the number of consecutive years an audit partner serves as the signing partner on an engagement for the client firm i
at the end of time period t;
STENUREit = client firm i in time period t is scored one (1) if audit partner is an engagement partner on the client firm for a period of
less than or equal to two years, and zero (0) otherwise;
BIG4it = client firm i in time period t is scored one (1) if the incumbent auditor j in time period t is a Big 4 audit firm, and zero
(0) otherwise;
PARTENUREit*BIG4it = interaction term between PARTENUREit and BIG4it;
FEEit*STENUREit = interaction term between alternative measures of non-audit services fees (RNONAUDITit, LNNASit, and ABNONAUDITit)
described earlier and STENUREit;
RNONAUDIT it*STENUREit = interaction term of RNONAUDIT it and STENUREit;
LNNAS it*STENUREit = interaction term of LNNASit and STENUREit;
ABNONAUDIT *STENURE = interaction term of ABNONAUDIT and STENURE ;
it it it it
AUDTENUREit = the number of consecutive years an incumbent audit firm has served the client firm i at the end of time period t;
PARTENSWITCH it = client firm i in time period t is scored one (1) if there is a change in the audit partner but the audit firm remains the
same, and zero (0) otherwise;
AUDFIRMSWITCHit = client firm i in time period t is scored one (1) if there is a change in the audit firm, and zero (0) otherwise;
DISTRESSit = client firm i in time period t is scored one (1) if the firm was financially distressed i.e. it either suffered a loss or
incurred a negative cash flow from operations, and zero (0) otherwise;
LOPINIONit = client firm i in time period t is scored one (1) if the auditor has issued a going-concern opinion in the previous year,
and zero (0) otherwise;
AGEit = the number of years client firm i has been listed on ASX at the end of time period t;
FEMALEit = client firm i in time period t is scored one (1) if the signing partner of the incumbent auditor j in time period t is a
female, and zero (0) otherwise;
MVEit = market value of equity in million dollars of client firm i at the end of time period t;
LNMVEit = natural logarithmic transformation of the market value of equity of client firm i at the end of time period t;
MKTBKit = market to book ratio, measured as the ratio of total market capitalization of firm i at the end of time period t to the
total book value of assets of firm i at the end of time period t;
SGRit = sales growth for client firm i at the end of time period t;
LOSSit = client firm i in time period t is scored one (1) if the firm reported a loss, and zero (0) otherwise;
LLOSSit = client firm i in time period t is scored one (1) if the firm reported a loss in the previous year, and zero (0) otherwise;
ROAit = the rate of return on assets of client firm i in time period t, calculated at earnings before interest and tax divided by
total assets;
LEVit = financial leverage, measured as the ratio of total debt of firm i at the end of time period t to the total assets of firm i at
the end of time period t;
CIRit = capital intensity ratio, measured as the ratio of gross value of property, plant and equipment of firm i at the end of time
period t to the total assets of firm i at the end of time period t;
SDREVit = sales volatility, measured as the standard deviation of sales (scaled by lagged total assets) of firm i at the end of time
period t where standard deviations are calculated based on rolling-windows of five annual observations;
TACit-1 = firm i’s total accruals from the prior year (t – 1), scaled by year t – 2 total assets;
INDUSTRYit = an industry indicator variable to control for industry effects;
YEARit = series indicator variables controlling time temporal differences of reporting periods for firm-year observations with
firm i scored one (1) if financial data corresponds to time period t, and zero (0) otherwise;
b = coefficients of independent and control variables 0 through 17; and
eit = the error term.
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Independent and Joint Effects of Audit Partner Tenure and Non-Audit Fees On Audit Quality

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Journal of Contemporary Accounting and Economics 15 (2019) 186–205

Contents lists available at ScienceDirect

Independent and joint effects of audit partner tenure

⇑ Corresponding author at: Curtin University, Perth, Western Australia, Australia.

3.1. Audit partner tenure and audit quality

3.2. Auditor NAS/abnormal NAS fees and audit quality

4.1. Earnings management models

4.2. Measurement of audit partner tenure and audit firm tenure

4.3. Measurement of auditor NAS/abnormal NAS fees

LNNASit ¼ b0 þ b1LNTAit þ b2BIG4it þ b3EQUITYit þ b4MERGACQSit þ b5ROAit þ b6LEVit þ b7NEG ROAit

All variables are defined in the Appendix.

4.4. Control variables

EMit ¼ b0 þ b1FEEit þ b2PARTENUREit þ b3PARTENUREit m BIG4it þ b4BIG4it þ b5AUDTENUREit þ b6AGEit

EMit ¼ b0 þ b1FEEit þ b2STENURE it þ b3FEEit m STENUREit þ b4BIG4it þ b5AUDTENUREit þ b6AGEit þ b7FEMALEit

Panel A: Sample Selection

Number of Firms Listed on the ASX as at 1 January 2008 2339

Panel B: Sample Firm Breakdown by Industry in 2008

Top 125 Firms Randomly Selected 125 Pooled Sample/Final

ASX Industry No. of % of No. of % of No. of % of

6. Data analyses and discussion

6.1. Descriptive statistics

Overall Sample (n = 1250) Sample Firms Sample Firms Audited Difference in

Control and Other Variables

6.2. Correlation matrix

A. Singh et al. / Journal of Contemporary Accounting and Economics 15 (2019) 186–205

6.3. Multivariate main results

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

Intercept 0.398 0.370 0.394 0.425 0.406 0.417

Variables (MJ|DACit|) (KOTHARI|DACit|)

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

6.4. Alternative measures of audit quality

OPINIONit ¼ b0 þ b1FEEit þ b2FEEit m STENUREit þ b3STENUREit þ b4BIG4it þ b5AUDTENUREit þ b6LOPINION it

All variables are defined in the Appendix.13

6.5. Alternative measures of abnormal NAS fees

6.6. Partitioning by signed earnings management

Column 1 Column 2 Column 3

Variables KOTHARI DACit+ KOTHARI DACit-

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

Variables KOTHARI DACit+ KOTHARI DACit-

Column 1 Column 2 Column 3 Column 4 Column 5 Column 6

6.8. Additional analyses

Variables Used in the Measurement of Earnings Management

(continued on next page)

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