The Effect of Engagement and Review Partner Tenure and

Rotation on Audit Quality: Evidence from Germany

Anna Gold*
VU University Amsterdam
anna.gold@vu.nl

Friederike Molls
Westfälische Wilhelms-Universität Münster
friederike.molls@wiwi.uni-muenster.de

Christiane Pott
Westfälische Wilhelms-Universität Münster
christiane.pott@wiwi.uni-muenster.de

Christoph Watrin
Westfälische Wilhelms-Universität Münster
christoph.watrin@wiwi.uni-muenster.de

*Corresponding author: Department of Accountancy (PGO); Faculty of

Economics and Business Administration; VU University Amsterdam; De
Boelelaan 1105; NL-1081 HV Amsterdam; The Netherlands; Tel: +31 20 59
82592

We thank the participants of the 2009 European Accounting Association Annual

Meeting, the 2009 Meeting of the Accounting Section of the German Academic
Association for Business Research (AS-VHB) in collaboration with the
International Association for Accounting Education and Research (IAAER), the
2009 Annual meeting of the German Academic Association for Business
Research (VHB), the 2009 EARNet Symposium, and the 2010 AAA American
Accounting Association Annual Meeting for many helpful suggestions. We
greatly appreciate the opportunity to use The Annual-Report-database available
from the Chair of Business Administration and Controlling at the Westfälische
Wilhelms-Universität Münster. All remaining errors are our own.

Electronic copy available at: http://ssrn.com/abstract=1631947

 The Effect of Engagement and Review Partner Tenure and
Rotation on Audit Quality: Evidence from Germany

Abstract:

This study contributes to the recent debate over the effect of audit partner tenure

and rotation on auditor independence, expertise and, ultimately, audit quality. We

investigate the effect of partner tenure and rotation on audit quality, using unique

1995-2010 data from all German listed companies for which we identify not only

the audit engagement but also the quality review partner. Using multiple absolute

and signed values earnings management measures as proxies for audit quality, we

find evidence of less income-reducing accounting with an increase in review

partner tenure (but not engagement partner tenure). Further, rotation of the review

partner (but not the engagement partner) is associated with more income-reducing

accounting. These findings underline the importance of distinguishing between

the two partner roles and support the expertise hypothesis with respect to the

review partner.

Keywords: Audit partner rotation; Audit partner tenure; Audit quality;

Review partner
JEL descriptors: G34, G38, M41, M42, M48

Electronic copy available at: http://ssrn.com/abstract=1631947

 The Effect of Engagement and Review Partner Tenure and
Rotation on Audit Quality: Evidence from Germany
1. Introduction

The harsh criticism of the auditing profession in the wake of corporate scandals

had a significant impact on regulators‘ activities worldwide. One issue early on

identified as potentially problematic (e.g., AICPA 1977; European Commission

1996) is the possibility of an excessive tenure period for audit partners, the

consequence of which might be that the auditor accepts questionable accounting

and reporting practices because of familiarity threats and/or in order to retain the

client. This reasoning is often referred to as the independence hypothesis (e.g.,

Mautz and Sharaf 1961; AICPA 1978; DeAngelo 1981a; SEC 1994; IFAC 2008).

As part of regulatory initiatives world-wide, the Sarbanes-Oxley Act (SOX 2002)

now requires rotation of both the audit engagement and review partner every five

(previously seven) years. Similarly, the 8th EU directive 2006/43/EC (European

Commission 2006) requires all 27 EU member states to implement mandatory

rotation of both engagement and review partners for audit reports dated after June

2008.1 The major expected benefit is that rotation will improve audit quality

because inappropriate accounting practices are more likely identified when a new,

and hence more independent, engagement partner assumes responsibility for the

audit (Carey and Simnett 2006). Meanwhile, opponents to the rotation

1
Member states are given discretion with regard to the exact rotation period.

2
requirement suggest a number of potential pitfalls that may counter the benefits.

Aside from the additional costs incurred to audit firms, a new partner may lack

the client-specific knowledge of risk, operations, and financial reporting practices,

which could potentially lead to lower audit quality—an argument known as the

expertise hypothesis (e.g., Solomon et al. 1999; Johnson et al. 2002). Therefore,

despite the widely adopted requirement of audit partner rotation, the standard‘s

consequences remain unclear and could be either beneficial or harmful for the

quality of the audit.

Recently, a few archival studies in Australia, Taiwan, and the United

States have examined tenure and rotation at the within-firm partner level by

observing signature changes on audit reports. With few exceptions (i.e., Chen et

al. 2008), results of these studies suggest that (excessive) tenure adversely affects

audit quality (Chi and Huang 2005; Carey and Simnett 2006; Manry et al. 2008)

and that audit quality is higher for firms under a mandatory partner rotation

regime than for firms not subject to rotation (Chi et al. 2009). Hence, these studies

largely support the independence hypothesis.

While prior studies have focused exclusively on tenure and/or rotation of

the engagement partner, relevant standards clearly require rotation of all key

partners, hence including the quality review partner (hereafter called ‗review

partner‘) alongside the engagement partner (e.g., SOX 2002; European

Commission 2006). The purpose of the engagement quality review is to provide

3
quality control for audit engagements and to serve as an evaluation of the

performance of the audit engagement partner and team (Epps and Messier 2007).

As such, the review partner plays a vital role in the audit review process and for

the attainment of a high quality audit; however, no prior research has examined

either tenure or rotation effects with respect to the review partner separately. In

Germany, both partners‘ signatures must be visible and identifiable in the audit

report and both partners are formally responsible for the audit (§ 322 HGB of the

German Commercial Code). This practice is a characteristic of the dual control

principle common in German business law. As such, German audit report data

offers the unique opportunity to examine tenure and rotation of the review partner

separately from the engagement partner by means of the location of their

respective signatures in the audit report. While (excessive) tenure of the

engagement partner has largely been shown to aggravate audit quality and there is

some evidence that engagement partner rotation provides a viable solution,

dynamics might be significantly different when considering the role of the review

partner. More specifically the review partner might be relatively less susceptible

to independence threats than the engagement partner, because involvement with

the client is less extensive and frequent due to the review partner‘s primary role of

quality control. Further, it is possible that the review partner would primarily

benefit from tenure and that rotation might reduce audit quality, because the

accumulated experience with the client is not always transferred to a new review

4
partner. While refraining from formulating directional hypotheses in this regard,

this paper contributes to the literature by examining whether explanations of

independence or expertise differ for tenure/rotation effects of the engagement and

review partner, respectively.

Consistent with prior studies (e.g., Chi et al. 2009), we examine these

effects using absolute and signed performance-matched abnormal accruals as

proxies for audit quality. We identify a sample of 2,636 firm-year observations for

the period 1995-2010 in Germany, hence including a period where partner

rotation was legally mandated from 2002 onwards.2 Descriptive results reveal that

in the German mandatory rotation setting, rotation occurs even more frequently

than the standard requires, such that the mean of partner tenure is less than three

years, and the great majority of German firms implement rotation of the review

partner (98.56%) and audit engagement partner (99.81%) before the seventh year

of tenure. Our regression results suggest that tenure of the review partner is

associated with an increase in audit quality (reflected by income-decreasing

accounting procedures), while rotation of the review partner leads to a significant

decrease in audit quality. Interestingly, audit quality is not significantly associated

with either engagement partner tenure or engagement partner rotation. Overall,

our paper provides evidence in favor of the expertise hypothesis, but only for the

review partner.
2
The standard was introduced retro-actively; meaning that engagement and review partners
starting in 1995 or earlier were forced to rotate ultimately by 2002.

5
 Our study contributes to the debate on mandatory auditor rotation in at

least two respects. First, in an extension of Chi and Huang (2005), Carey and

Simnett (2006), Chen et al. (2008), and Manry et al. (2008), our analysis provides

new empirical evidence by using financial reports on partner (and firm) level

rotation and tenure data in a highly developed audit environment, i.e., Germany.

Second and more importantly, our unique distinction between engagement partner

and review partner signatures allows us to differentiate between tenure and

rotation of these two partner roles, respectively, and to further disentangle

competing hypotheses of expertise and independence. Although our findings are

in part based on a time period preceding the introduction of mandatory rotation,

we believe study results are interesting for policy makers and regulators in

countries where empirical investigation of engagement and review partner tenure

and rotation is difficult or impossible (e.g., the United States).

The remainder of the paper is organized as follows. Section 2 describes

recent key policy initiatives in the areas of audit partner rotation and the role of

the review partner in major jurisdictions (including Germany), reviews related

empirical literature, and develops study hypotheses. Section 3 discusses the

research design, sections 4 and 5 report the empirical results, and section 6

concludes the paper.

6
2. Recent key policy initiatives, literature review and hypotheses

Audit partner tenure and rotation

Audit partner rotation is required in many countries, but the maximum tenure

allowed varies considerably. In the 1970s, the United States was the first

legislation to require rotation of the audit partner after seven years of tenure on

audits of SEC-registered clients. With the implementation of SOX in 2002, the

rotation period was further reduced to five years for public company engagements

and now includes the rotation of both the engagement partner and the review

partner. Similarly, the Department of Trade and Industry and the U.K. Treasury

implemented a regulation that requires rotation of the lead engagement partner

after five years and of other key engagement partners after seven years. By the

end of June 2008, all member states of the European Union were required to enact

the revised 8th Directive‘s requirements into national law (European Commission

2006). One important detail of the Directive is rotation of the key audit partner,3

but member states are given discretion regarding the maximum tenure allowed.

Even before the EU Directive was issued, Germany had revised its

Commercial Code by means of the ‘Gesetz zur Kontrolle und Transparenz im

Unternehmensbereich’ implemented in March 1998, with the rotation requirement

3
The key audit partner is typically the partner that signs the audit report, but may also denote
either (a) the statutory auditor(s) designated by an audit firm for a particular audit engagement as
being primarily responsible for carrying out the statutory audit on behalf of the audit firm; or (b) in
the case of a group audit, at least the statutory auditor(s) designated by an audit firm as being
primarily responsible for carrying out the statutory audit at the level of the group and the statutory
auditor(s) designated as being primarily responsible at the level of material subsidiaries.

7
becoming effective in 2002. As a result, an audit partner was forced to rotate from

the engagement if he/she had signed the audit report six times during a ten-year

auditor-client relationship. The ‘Bilanzrechtsreformgesetz’ in October 2004

modified the existing requirement to a situation where rotation was mandated

after a seven-year engagement. This law is considered a direct response to SOX

(2002) and the European Commission Recommendation (European Commission

2002) (Veltins 2004).4 Next, we discuss prior research and develop hypotheses

regarding the potential effects of engagement partner tenure and rotation on audit

quality.

Engagement partner tenure, rotation, and audit quality

Audit quality is defined as the joint probability that an auditor will both detect and

report material misstatements (DeAngelo 1981b). According to this definition,

audit quality is a function of the auditor‘s ability to detect material misstatements

(auditor expertise) and to report those detected misstatements (auditor

independence). Prior literature and theory explain how the length of the

relationship between the auditor and the client (i.e., tenure) may affect audit

quality. Interestingly, there is an inherent conflict regarding such effects, as

4
As part of this major reform, § 319a HGB was issued for public interest companies. This
legislation defines circumstances under which an auditor must immediately be excluded from the
audit. Beyond the reasons stated in § 319 II and III HGB, an auditor is also excluded from the
audit of a client using an organized market, as defined in § 2 V Securities Trading Act4
(Wertpapierhandelsgesetz), if the key audit partner(s) has issued (i.e. signed) the audit opinion
(Bestätigungsvermerk–§ 322 HGB) for seven or more consecutive years (§ 319a I no. 4). This
requirement is waived if there has been a cooling-off period of three or more years since the last
audit.

8
reflected by the hypotheses of independence and expertise (e.g., Mautz and Sharaf

1961; Shockley 1981; Iyer and Rama 2004).

On one hand, audit quality may be compromised as auditor tenure

increases, an argument often referred to as the independence hypothesis. More

specifically, an increase in audit partner tenure might introduce a familiarity threat

to auditor independence (IFAC 2008). The IFAC Code of Ethics states that a

―familiarity threat occurs when, by virtue of a close relationship with an assurance

client, its directors, officers or employees, a firm or a member of the assurance

team becomes too sympathetic to the client‘s interests‖ (IFAC 2008, p. 18). This

threat could result in a decline in the audit partner‘s ability to accurately judge the

company‘s performance and the client‘s reporting decisions. A related

explanation is the threat of routine. While an audit partner will likely apply

creative approaches to audit-testing in the early years of tenure (AICPA 1978;

Hoyle 1978; McLaren 1958), deeper knowledge over time about the client‘s

systems and control procedures may result in more routine audit programs (Hoyle

1978). Shockley (1981, p. 789) asserts that ―complacency, lack of innovation, less

rigorous audit procedures and a developed confidence in the client may arise after

a long association with the client.‖ The major concern is that prior year audits

may cause the partner to anticipate current results instead of carefully and

objectively examining the current year‘s data for material misstatements

(Arrunada and Paz-Ares 1997). In conclusion, the independence hypothesis

9
predicts that auditor tenure is negatively associated with audit quality, while

auditor rotation would have positive outcomes.

In contrast, the expertise hypothesis (e.g., Solomon et al. 1999; Johnson et

al. 2002) contends that audit quality may increase with auditor tenure because the

auditor gains more knowledge of the client and the client‘s industry over time.

This explanation is based on information asymmetry between the client and the

auditor, which decreases over time, as the auditor acquires client- and industry-

specific knowledge. Because increased client-specific knowledge provides a

comparative advantage in detecting material misstatements in financial reports,

lack of this knowledge in the early years of an audit engagement may result in a

lower quality audit, while tenure should have a favorable effect on audit quality

(Beck et al. 1988; Hoyle 1978; Knapp 1991; Solomon et al. 1999; Geiger and

Raghunandan 2002; Myers et al. 2003). Consequently, auditor rotation would

have adverse effects on audit quality according to the expertise hypothesis.

Given the limited availability of empirical data on the association between

auditor tenure/rotation and audit quality at the audit partner level, most prior

research has examined this relationship at the audit firm level. Archival evidence

on audit firm tenure shows mixed results as to which theory dominates with

respect to audit quality – the independence hypothesis (e.g., Kealey et al. 2007;

Mansi et al. 2004; Stanley and DeZoort 2007) or the expertise hypothesis (e.g.,

Carcello and Nagy 2004; Davis et al. 2009; DeFond and Subramanyam 1998;

10
Ghosh and Moon 2005; Johnson et al. 2002). However, Bamber and Bamber

(2009) caution that findings based on audit firm rotation may not be generalizable

to audit partner rotation, because of different cost and benefits effects.

Recent archival research has considered the issue of rotation and tenure at

the engagement partner level and provides mixed results. The mandatory

inclusion of partner signatures on audit reports in some countries, such as

Australia and Taiwan, has enabled such endeavors. Carey and Simnett (2006)

conducted one of the first studies in this area by examining Australian listed

companies. The authors reach varying conclusions, depending on the measure of

audit quality used. The non-Big 6 (but not Big 6) auditors‘ propensity to issue

going-concern audit opinions for distressed companies was less likely as audit

partner tenure increased. However, the authors found no evidence of an

association between audit partner tenure and either the signed or absolute amount

of abnormal working capital accruals. Using Taiwanese data, Chi and Huang

(2005) found that engagement partner (and audit firm) tenure initially led to

higher earnings quality (particularly for Big 5 auditors), but excessive familiarity

with the client (i.e., more than five years) negatively affected earnings quality.

Again using a sample of Taiwanese companies, Chen et al. (2008) found that the

absolute and positive values of discretionary accruals decreased significantly with

audit partner tenure, hence leading to an increase in audit quality. Chi et al. (2009)

investigated the effects on audit quality of the mandatory audit partner rotation

11
implemented in Taiwan in 2004. Using absolute and signed abnormal accruals

and abnormal working capital accruals as proxies for audit quality, they found

that in 2004, audit quality was higher for companies subject to the mandatory

rotation regime than for firms not subject to rotation. Finally, the only United

States study on audit partner tenure to date (Manry et al. 2008) found that partner

tenure was positively associated with audit quality, using estimated discretionary

accruals as a proxy. Excessive tenure (i.e., more than seven years) again had

negative effects on audit quality, but only for small clients.

In experimental settings, partner rotation decreases auditors‘ willingness to

issue biased audit reports (Dopuch et al. 2001) and strengthens independence in

appearance of non-professional investors (Kaplan and Mauldin 2008), suggesting

that partner rotation may have favorable effects on audit quality. However, while

audit firm rotation evoked higher confidence in financial statements by MBA and

law students, partner rotation did not have this effect (Gates et al. 2007).

In summary, archival and experimental results are inconsistent with

respect to the association between engagement partner tenure/rotation and audit

quality. Some research supports the independence hypothesis; other results

confirm the expertise hypothesis. Some studies even fail to find an effect of

tenure/rotation on audit quality, which could indicate that the two explanations

compensate for each other. Because no solid theoretical support is available to

predict directional hypotheses, we posit two null hypotheses to empirically test

12
these relationships in the German setting, which uniquely allows us to isolate

engagement partners from engagement quality review partners.

HYPOTHESIS 1a: Engagement partner tenure is not associated with audit

quality.

HYPOTHESIS 1b: Engagement partner rotation is not associated with audit

quality.

Next, we consider how tenure and rotation of the review partner may affect audit

quality.

Quality review partner tenure, rotation, and audit quality

The general purpose of the engagement quality review is to provide

quality control for audit engagements and to serve as an evaluation of the

performance of the engagement partner and the engagement team (Epps and

Messier 2007). The potential strengths of the review partner are manifold. First,

while the engagement partner is susceptible to familiarity threats (leading to

possibly favorable attitudes toward the client and potential reluctance in the final

review stage to challenge or question decisions made in earlier stages), the review

partner has significantly less interaction with the client, which may reduce such

familiarity threats in the first place (Schneider et al. 2003). Second, review

partners typically hold little accountability toward the client but have considerable

knowledge about the client‘s industry; therefore, they offer an opportunity for

objective and high-level judgments and decisions (Matsumura and Tucker 1995;

13
Rich et al. 1997). According to German audit standards, the review partner‘s

responsibilities include obtaining information about the fundamental content of

the audit opinion, the structure of the audit, and its material aspects. Furthermore,

adequate information procurement includes a critical review of the audit report.

Consistent with other legislations, a review of the audit report by a separate

review partner who is not involved in planning and conducting the audit is

mandatory for German financial statement audits (§ 24d II BS WP/vBP–

Berufssatzung für Wirtschaftsprüfer/vereidigte Buchprüfer). The review process

consists of evaluating whether the audit procedures and audit results are

consistent (§ 24d I BS WP/vBP).

Germany provides a unique setting for researchers, because both the

engagement partner and the review partner are formally responsible for the audit

and the reasonableness of the audit opinion, and both partners‘ signatures must be

visible and identifiable in the audit reports (§ 322 HGB of the German

Commercial Code).5 By providing signatures in the audit report, both partners

accept the role as key audit partners with the consequence of having to rotate after

seven years of tenure with the audit client. Relevant to our study, it is common

dual control practice in Germany that the review partner‘s signature is located on

5
Although the 8th EU directive requires only the signature of one audit partner responsible for the
audit, it is German audit practice to provide the signature of the review partner in addition.
Providing both signatures in the audit report is a characteristic of the dual control principle
common in German business law. For instance, legislation mandates company representation by at
least two directors (§ 709 Abs. 1 BGB und § 35 Abs. 2 Satz 1 GmbHG, § 77 Abs. 1 Satz 1 AktG)
and dual quality control of audit firms (§ 24d Abs. 1 Satz 1 BS WP/vBP).

14
the lower left-hand side of the audit report, next to the right-hand side signature of

the engagement partner (§ 27a BS WP/vBP).6 Both engagement partner and

review partner have reached partner level and typically work for the same audit

firm. 7 The review partner‘s signature implies that the signer is sufficiently

familiar with the audit to be able to take co-responsibility for the audit opinion.

Although recently established regulation in Germany and elsewhere

underlines the importance of the engagement quality review as an effective

technique to uncover potential failures and detect deficiencies in financial

statements (Luehlfing et al. 1995), only a handful of (experimental and analytical)

studies to date have examined audit review partner effectiveness with respect to

audit quality. In an experiment, Kraut and Davidson (1998) found that review

partners‘ audit opinions (vis-à-vis engagement partners) were influenced by

neither client importance nor the importance of the client‘s industry, thus

confirming their relative strength in independence. Matsumura and Tucker

investigated analytically and experimentally how engagement partners respond to

6
To verify this signature practice for our study, we elicited survey responses of more than half of
the audit firms in our sample. The results clearly support that the signature on the left-hand side of
the audit report always identifies the person who conducted the quality review. Furthermore, to
support the survey results, we received the internal directives on quality assurance detailing the in-
house practice of three of the Big 4 audit firms. The directive explicitly states that the partner
providing the audit quality review signs the left-hand side of the audit report and the audit
engagement partner signs the right-hand side of the report. Thus, we can safely conclude that the
location of the signature in the audit report informs us of the role that an individual served during
the audit process (Gelhausen 2007).
7
As explained in more detail in our results section, we observe 24 joint audits in our sample
suggesting that two firms jointly conducted the audit and therefore a total of four partners (two
engagement partners and two review partners) sign the audit report (i.e., four signatures).
Controlling for joint audit cases in our regression models does not change our results.

15
the presence of a review partner and found that engagement partners planned

higher levels of audit testing (Matsumura and Tucker 1995) and exhibited less

reporting bias (Tucker and Matsumura 1997) in the presence of a review partner.

Without second-partner reviews, engagement partners showed significantly more

strategic behavior in their reporting. Similarly, Ayers and Kaplan (2003) found

that engagement partners performed better audit risk assessments during client

acceptance in the presence of a review partner.

To our knowledge, no prior research has investigated the effect of auditor

tenure or rotation on review partners‘ reporting decisions, with two notable

exceptions employing experimental methods. First, Favere-Marchesi and Emby‘s

(2005) results revealed that continuing review partners (i.e., those with prior

involvement in the previous year‘s engagement) were less likely than new review

partners (i.e., no prior involvement) to reach conclusions that differed from the

engagement partner when the evidence refuted the engagement partner‘s view.

This finding may suggest that not even review partners are immune to potential

independence threats. However, Schneider et al. (2003) manipulated prior review

partner involvement in audit planning and found that the degree of a review

partner‘s agreement with an engagement team‘s conclusion was unaffected by

prior involvement; hence, this finding suggests that review partners have the

ability to remain objective.

16
 On one hand, we suggest that the likelihood of independence threats due to

tenure could be significantly lower for review partners than for engagement

partners. Review partners remain at a greater distance from the client and are less

involved in daily audit practices. Given such circumstances, they are in a unique

position to enjoy the learning benefits without risking the accompanying and

potentially detrimental independence threats. Hence, the expertise hypothesis

could more likely be at stake for review partners as compared to the independence

hypothesis. However, as suggested by the experimental results of Favere-Marchei

and Emby (2005), even review partners appear to be susceptible to bias in their

reporting decisions. Given limited and inconclusive prior research evidence, we

posit two null hypotheses to empirically test the association between review

partner tenure and audit quality, and review partner rotation and audit quality,

respectively:

HYPOTHESIS 2A: Review partner tenure is not associated with audit

quality.

HYPOTHESIS 2B: Review partner rotation is not associated with audit

quality.

3. Research design

Sample

Our data were obtained from two different sources. First, the accruals data were

obtained from the Compustat Global Industrial database. As shown in Table 1, the

17
initial sample consisted of 9,597 firm-year observations of German listed

companies, excluding financial institutions and insurance companies and covering

the period 1995-2010. We removed 4,026 observations with missing accrual

items.

[Insert Table 1 about here]

The data on audit firm, audit engagement, and review partner signatures

was manually collected either from an Annual Reports database containing

consolidated financial statements or from the respective company‘s website. We

collected data from all German-listed companies for which annual financial

statements including the auditor‘s report were available. Our final sample consists

of 2,636 firm-year observations including data on the audit firm, audit

engagement and audit review partner.

Empirical model

Audit quality can be measured in multiple ways. Experimental and survey

research commonly assesses perceptions of audit quality (for a review, see Quick

2004). Proxies for audit quality in archival research include materiality judgments

(e.g., Kemp et al. 1983), propensity to issue unqualified audit opinions (e.g.,

Vanstraelen 2000) and audit firm litigations (e.g., Latham et al. 1998). More

recent studies have used a firm‘s accrual accounting behavior as a proxy for audit

quality (e.g., Myers et al. 2003, Chi et al. 2005, Carey and Simnett 2006; Francis

and Wang 2008; Cameran et al. 2008). Lower accrual levels are associated with

18
greater auditor conservatism and are interpreted as indicating higher quality

audits, mitigating extreme management reporting decisions. Johnson et al. (2002)

and Myers et al. (2003) use the Jones 1991 model-estimated abnormal accruals as

proxies for audit quality. Consistent with Chi et al. (2009), we use the modified

Jones model (Dechow et al. 1995) to estimate abnormal accruals.

Assuming that the total accruals of a firm can be divided into discretionary

and non-discretionary accruals and that the apportionment cannot be observed,

our measure estimates discretionary accruals. Following Dechow et al. (1995), we

calculate total accruals as the change in current accruals

minus the change in current liabilities other than financial liabilities

and less depreciation :8

(1)

Where

= Total accruals of firm i in year t

= Non-discretionary accruals of firm i in year t

= Discretionary accruals of firm i in year t

= Change in current assets of firm i from year t to year t-1

8
We are aware of the limitations of using balance sheet data to partition net income into accruals
and operating flows (Collins and Hribar 2002). However, in accordance with prior research using
international data (e.g., Leuz, Nanda and Wysocki 2003) we use the indirect approach to compute
total accruals, due to the lack of cash flow data for international firms in the commonly used
databases.

19
 = Change in cash of firm i from year t to year t-1

= Change in current liabilities of firm i from year t to year t-1

= Change in short-term debt of firm i from year t to year t-1

= Depreciation of firm i in year t

Our measure is a modification of the original Jones model (Jones 1991), that is,

we use the cash flow Jones model (Kasznik 1999). These models are both based

on the assumption that the model indicates non-discretionary accruals. They

assume non-discretionary accruals as a component of total accruals for an

estimation period, which is not (or at least less) affected by earnings management.

The coefficients resulting from this regression are used to estimate the total

accruals of the firms in the actual sample period. Comparing the results from this

regression to the expected total accruals calculated by the model (equation (1))

results in differences that are considered to be discretionary accruals. To control

for industry-specific effects on the accruals, the model is calibrated separately for

each industry sector. The original Jones model (Jones 1991) is based on the idea

that the non-discretionary part of the accruals is dependent on economic

conditions of each firm. Therefore, property, plant and equipment and

change in revenues are included in the model to control for changes in

non-discretionary accruals caused by changing conditions.

The original Jones model is modified in multiple ways. The model implies

that changes in revenues are non-discretionary. Dechow et al. (1995) modified the

20
Jones model by reducing the revenues by the receivables as receivables could

increase current assets if they include bad debt. Kasznik (1999) included a change

in the cash flow. This model assumes that the accruals of a current period are

dependent on the cash flows of the previous period. Therefore the coefficients of

the cash flow Jones model (Kasznik 1999) are estimated for each industry sector

based on the following equation9:

(2)

Where

= Last year‘s total assets of firm i in industry sector p

= Change in revenues of firm i in industry sector p

= Change in receivables of firm i in industry sector p

= Property, plant and equipment of firm i in industry sector p

= Change in cash flow of firm i in industry sector p

All variables are scaled by total assets to control for size effects and to reduce the

possibility of heteroscedasticity. To test hypotheses H1a and H2a, we examine the

impact of audit engagement tenure (EPTENURE) and review partner tenure

(RPTENURE) on earnings management using the following regression model:

9
In non-tabulated tests we compare the explanatory power of five different measures to estimate abnormal
accruals: the Jones 1991 model, the modified Jones model, the cash flow model, the performance-matched
Jones and modified Jones model. We selected the measure of abnormal accruals with the most consistent R-
square overall for our different industry sectors, leaving us with the cash flow model.

21
 (3)

Where

= discretionary accruals by cash flow Jones

measured in absolute, positive and negative values
= years of tenure of the engagement partner
conducting the audit (i.e., first year = 1; second year
= 2; etc.)
= tenure of the engaged review partner
= tenure of the engaged audit firm
= dummy variable equal to ―1‖ if the auditor is from a
Big 4 audit firm, and equal to ―0‖ otherwise
= sales growth rate calculated as the sales in year t
minus sales in t-1 and scaled by sales in year t-1
= natural logarithm of total sales
= cash flow in year t scaled by total assets in year t-1
= ratio of retained earnings to total common equity

To test hypotheses H1b and H2b, we examine the impact of audit engagement

partner switches (EPS) and review partner switches (RPS) on earnings

management using the regression model below.

(4)

Where

= discretionary accruals by Jones measured

22
 in absolute, positive and negative values
= dummy variable equal to ―1‖ if the audit
engagement partner was switched from t-1 to t, and
equal to ―0‖ otherwise
= dummy variable equal to ―1‖ if the audit review
partner was switched from t-1 to t, and equal to ―0‖
otherwise
= tenure of the engaged audit firm
= dummy variable equal to ―1‖ if the auditor is a Big 4
audit firm, and equal to ―0‖ otherwise
= sales growth rate calculated as the sales in year t
minus sales in t-1 and scaled by sales in year t-1
= natural logarithm of total sales
= cash flow in year t scaled by total assets in year t-1
= ratio of retained earnings to total common equity

Consistent with prior studies (Cameran et al. 2008; Chi et al. 2009), we use the

exact value, the absolute value, and the signed values of accruals as dependent

variables for our measures. To control for industry-specific effects, we use one-

digit codes from the North American Industry Classification system (NAICS). We

further include fixed effects for year.

We include several control variables for other known determinants of

accruals in our model (l) (e.g., Chen et al. 2008; Chi et al. 2009; Myers et al.

2003). First, we include audit firm tenure in our models to control for any effect

on audit quality from the number of years that a given audit firm has been

performing the audit. Moreover, since accrual models are often unable to

completely capture the effects of companies‘ performance on nondiscretionary

accruals (Dechow et al. 1995; Kothari et al. 2005), we include cash flow to

control for the nondiscretionary component of accruals, which is not extracted by

23
our accrual model. We include lifecycle to control for changes in accruals over a

company‘s life cycle (Anthony and Ramesh 1992; Dechow et al. 2001).

Furthermore, the size of a company determines its earnings management behavior

in the sense that larger companies face higher political costs (Watts and

Zimmerman 1983; 1986; 1990) and higher litigation risk (Lang and Lundholm

1993). In addition, larger companies tend to report larger and more stable accruals

(Dechow and Dichev 2002). The growth of a company‘s sales is likely to increase

the absolute value of accruals. Finally, we control for Big4 audit firms, which tend

to be more conservative and to limit their clients‘ extreme accruals more than

non-Big 4 firms. However, findings related to this argument are mixed (Myers et

al. 2003).10

4. Results

Descriptive results

Panel A of Table 2 shows the distribution of audit engagement and review partner

switches over the entire sample period and other descriptive details on the joint

and individual rotation of audit partners as well as audit firms.

[Insert Table 2 about here]

Out of a total of 2.636 audits, 758 (687) engagement partner (review

partner) switches occurred during our sample period, compared with 1.878

10
Results remain unchanged when we include leverage calculated as total liabilities/equity in all
our models. However, since our sample size decreases to 2,367 we refrain from the inclusion of
leverage in our main tests.

24
(1.949) observations during which no partner switch took place. Thus, we find

engagement (review) partner switches in about 29 percent (26 percent) of the

observations. In 124 cases of the 758 engagement partner switches (about five

percent), the engagement partner became review partner. Out of 687 review

partner rotations, 58 partners (about two percent) rotated to a role as engagement

partner.11 Further, rotation at the audit firm level occurred for 228 audit

engagements, constituting about nine percent of all audits in the sample. In 189

cases (about seven percent) the engagement partner rotated simultaneously with

the audit firm. The review partner rotated with the audit firm in 199 (about eight

percent) out of 228 audit firm switches. 12

Panel B of Table 2 shows details on firm tenure,13 engagement partner

tenure and review partner tenure for the full sample as well as for the five

subsamples, corresponding to the five different indices of the German stock

exchange, i.e. DAX30, MDAX, TecDAX, SDAX and CDAX. The average audit

firm tenure is 5.23 years. The engagement partner rotates on average after a

period of 2.55 years, whereas the average review partner tenure is slightly longer

with 2.80 years.14,15 We find similar mean values for the subsample of firms listed

11
We provide additional tests related to the rotation from one the other audit partner role in the
sensitivity analysis section.
12
We provide additional tests related to the simultaneous rotation in the sensitivity analysis
section.
13
Since we do not know for how long switching audit firms audited a given company before 1995,
the descriptive details cannot be interpreted as the real-world mean of audit firm tenure.
14
Audit partner tenure is relatively short in Germany, which might be explained by the so-called
high-reputation mandates. Audit firms in Germany strive to improve individual partner profiles by

25
in the TecDAX, SDAX and CDAX; however, for the DAX30 (MDAX)

subsamples mean values are notably higher with 7.76 (6.04) years of average firm

tenure, 3.36 (2.78) years of average engagement partner tenure and 3.30 (3.04)

years of average review partner tenure.16

Panel C of Table 2 shows the mean, median, and standard deviation for the

exact, absolute, positive, and negative values of the cash flow Jones discretionary

accruals. As shown, the exact value of our accruals measure is positive, which

indicates earnings management behavior in the overall sample. 17 Splitting the

overall sample into firms with increasing and decreasing discretionary accruals

results in a slightly unbalanced division of 1,347 (positive) and 1,289 (negative)

companies, respectively. However, the average magnitude of positive cash flow

Jones discretionary accruals (0.0685) is not significantly different from the

negative cash flow Jones discretionary accruals (0.0709); hence, we observe no

frequently rotating partners to different, high-quality clients. As a result, frequent rotation of

partners was considered common practice in German audit firms even before mandatory rotation
was introduced.
15
We find five companies with partner tenure longer than seven years implying a violation of the
existing rotation requirement. Two companies feature audit engagement partner tenure of eight
and nine years, respectively. One company features review partner tenure of eight years. One
company features audit engagement partner tenure of eight and review partner tenure of nine
years. All of our reported results are robust to the exclusion of the violation instances.
16
We control for listing in the different indices of the German stock exchange in the sensitivity
analysis. Overall, our results for all accrual measures are unaffected.
17
The mean value of the absolute cash flow Jones accruals (0.06969) and absolute abnormal
working capital accruals (0.0779) is slightly higher than the absolute abnormal working capital
accruals reported for a German sub-sample based on abnormal working capital accruals (0.062)
identified by Maijoor and Vanstraelen (2006).

26
overall dominance of either income-increasing or income-decreasing earnings

management in our sample. 18

Main results

To test hypotheses H1a and H2a, Table 3 provides the results of estimating

model (3) with cash flow Jones discretionary accruals as the dependent variable

and engagement and review partner tenure as our main independent variables. We

use absolute accruals measures as well as positive and negative accruals as our

dependent variable specifications. Following Myers et al. (2003) and Chi et al.

(2009) we report our findings from the truncated regressions instead of ordinary

least squares regression for the positive and negative accruals sub-samples, to

avoid biased coefficient estimates (Greene 2000).

[Insert Table 3 about here]

For absolute measures of cash flow Jones discretionary accruals, we find a

significant negative effect of review partner tenure (p<0.10). That is, longer

tenure of the review partner leads to a decrease in the overall magnitude of

earnings management, independent of the direction of accruals. Observing the

18
The correlation matrix (see Table 7) indicates strong correlation between our variables of
interest. To ensure that correlation among the predictors does not lead to ill-conditioned regression
we calculate variance inflation factors (VIF) and tolerance values for all relevant variables to
detect possible collinearity between the independent variables in the regression models. Values of
VIF exceeding 10 are often thought to indicate multicollinearity, but, in weaker models, values
above 2.5 may be a cause for concern. A small tolerance value indicates that the variable under
consideration is an almost perfectly linear combination of the independent variables already found
in the equation and that this variable should not be added to the regression equation. VIF values
for our models range from 1.02 to 1.57 and tolerance values range from 0.63 to 0.98. Thus, we do
not observe issues of multicollinearity in our models.

27
signed values of cash flow Jones discretionary accruals by splitting our sample

into positive and negative accruals, we find a positive effect of review partner

tenure for the negative accruals sub-sample (p<0.10). Overall, these results imply

that longer review partner tenure leads to less extreme income-decreasing

accounting, while engagement partner tenure is associated with none of the three

specifications of the cash flow Jones discretionary accruals. To test hypotheses

H1b and H2b, we run the regression model (4) again with the cash flow Jones

discretionary accruals as the dependent variable and engagement and review

partner rotation as our main independent variables (see Table 4).

[Insert Table 4 about here]

First, for absolute measures of cash flow Jones discretionary accruals, we

find a significant positive effect of review partner rotation (p<0.05). That is,

rotation of the review partner leads to an increase in the overall magnitude of

earnings management, independent of the direction of accruals. After splitting our

sample into firms with positive and negative accruals, we observe more extreme

income-decreasing earnings management, and hence lower audit quality, after a

review partner switch (p<0.01). In other words, a new review partner constrains

extremely negative accruals to a smaller extent than the preceding review

28
partner.19 We find no evidence suggesting a change in accounting behavior after

rotation of the engagement partner.

Finally, results indicate that audit firm tenure is negatively associated with

absolute measures of cash flow Jones discretionary accruals (p<0.05). An

examination of the signed values of accruals reveals that an increase in audit firm

tenure leads to less income-increasing earnings management.20

5. Sensitivity analyses

Alternative accrual measures

We test the robustness of our results using four alternative measures of accruals.

First, we calculate abnormal accruals using two alternative approaches: (1)

performance-matched abnormal accruals estimated using the Jones 1991 model

and (2) performance-matched abnormal accruals estimated using the modified

Jones model. Prior research suggests that current accruals are more sensitive to

earnings management than total accruals. Thus, measures of current accruals or

working capital accruals might more readily capture earnings management or

audit quality than measures based on total accruals. Second, we adopt current

19
Univariate results support this finding. More specifically, we find a significant difference and
higher negative discretionary accruals in the period following a review partner switch.
20
We repeat all of our analyses using different control variable specifications (not tabulated).
First, when measuring SIZE as the logarithm of total assets, the results are similar. Furthermore,
when GROWTH is measured as the annual change in total assets or change in sales, the results
remain equally unchanged. Finally, we re-perform our main analysis with the exclusion of audit
firm switches. Our results remain constant.

29
accruals21 and abnormal working capital accruals 22 as two additional measures of

audit quality.

[Insert Tables 5 and 6 about here]

With accruals estimated by these four alternative approaches, we re-

estimate models (3) and (4). For brevity, we only report the coefficients on

EPT/RPT and EPS/RPS in Tables 5 and 6, respectively. We again use absolute

accruals measures, as well as positive and negative accruals as our dependent

variable specifications. Overall, findings are in accordance with our primary

results, with few exceptions. First, as shown in Table 5, review partner tenure is

significantly and negatively associated with three of the four absolute accruals

(see Panel A), and with two of the four negative accruals (see Panel B),

suggesting that longer review partner tenure leads to less income-decreasing

accounting, consistent with our primary results. Second, Table 6 shows that

review partner rotation leads to more income-decreasing accounting for all of the

alternative accrual measures, in accordance with our primary results. Finally,

results pertaining to the tenure and rotation of the engagement partner are not

21
We define Current Accruals following Myers et al. (2003).
/ 1, where = change in current assets between the first half of year t and
the second half of year t - 1; = change in cash and cash equivalent between the first half
of year t and the second half of year t - 1; = change in current liabilities between the first half
of year t and the second half of year t - 1; , = change in short-term debt between the first
half of year t and the second half of year t - 1 ; = total assets at the end of year t – 1.
22
We define Abnormal Working Capital Accruals, following DeFond and Park 2001.
where = noncash working capital at the
end of the first half of year t = (current assets - cash and cash equivalent) - (current liabilities -
short-term debt); SALES, = sales revenue in the first half of year t.

30
significant. Thus, our findings related to partner tenure and rotation are robust

across four alternative accrual-based measures of audit quality.

Difference-in-difference analysis

We perform a difference-in-difference analysis, where all companies

experiencing a rotation of one of the two respective partners (treatment group) are

matched with a weighted average (using propensity scores based on year and firm

size) of all companies not experiencing a rotation (control group). Again, we

perform these tests for our three main dependent variable specifications (absolute,

positive and negative cash flow Jones discretionary accruals).

Results support our main findings. Absolute accruals of companies with a

review partner switch are significantly higher (t=3.31, p<0.05) compared to

matched companies with no rotation, suggesting a positive difference in absolute

accruals. Furthermore, companies with a review partner switch have more

negative accruals (t=-3.49, p<0.05) compared to matched companies with no

rotation. We do not find a significant difference in accruals between companies

experiencing an engagement partner switch and those that do not.

Joint, exclusive and one-of-both partner rotation

To further validate our findings, we analyze rotation effects in more detail.

Previously reported descriptive evidence indicates that different rotation

constellations exist in the sample period, which might potentially affect our

31
results differentially. Non-tabulated findings from four regression analyses

provide further insights into the various possibilities. First, a rotation effect might

be present only if there is a joint rotation of the engagement and the review

partner (EPS & RPS); however, we find no support for this contention. Second, it

is possible that rotation affects audit quality, regardless of which partner rotates

(EPS or RPS); indeed, regression results preliminarily indicate that this is the

case. However, (third and fourth) regression results pertaining to engagement

partner rotation or review partner rotation only (EPS versus RPS) suggest that

audit quality is affected only by rotation of the review partner but not the

engagement partner, consistent with our primary results.23

From engagement to review partner and vice versa

Descriptive evidence indicates that in 124 (58) cases the engagement (review)

partner rotated to become the review (engagement) partner. To ensure that these

specific forms of rotation do not drive our results, we run two regression models

(not tabulated) comparing switches from one to the other audit partner role against

the remaining switches. We observe no effect on audit quality of rotation from

one to the other partner role. However, extending all our primary models to

control for differences in audit quality for the above-mentioned cases strengthens

our main results. This indicates that audit quality changes can be solely attributed

23
Our results hold when we instead include additional control variables in all our main regression
models for joint, exclusive and one-of-both rotation.

32
to regular rotation effects but not to switches in the role, i.e., from audit to review

partner and vice versa for the same audit.

Additional test on partner tenure

Our sample includes 30 (23) cases where the review (engagement) partner

rotates after the required tenure period of seven years. In 23 cases the review

partner rotates after the seven-year period but the engagement partner rotates after

less than seven years. A total of 16 companies experience a rotation of the audit

engagement partner after seven years but the review partner rotated before. In

seven cases both partners rotate jointly after seven years. An exclusion of the

above-mentioned cases leads to unchanged results for our main models indicating

no difference between audit firms that comply with the rotation requirement and

those that don‘t.

To further investigate the effect of the longest partner tenure (independent

of the function of the two partners) we perform additional tests (not tabulated).

More specifically, we include one variable that captures the longest tenure of

either the respective audit engagement or review partner tenure. Results indicate

no significant effect on any of our accruals specifications proxying for audit

quality; hence, we conclude that the distinction between the engagement and

review partner function is adequate. Dependent on the partner function we find

different effects on audit quality consistent with our main analysis.

33
6. Conclusion

The effectiveness of audit partner rotation as a mechanism to maintain audit

quality remains an unresolved issue worldwide. Proponents of mandatory audit

partner rotation argue that an increase of auditor tenure might impair audit partner

independence. Opponents believe that sufficient tenure is required to generate

requisite knowledge about the client and hence produce high quality audits.

However, the empirical evidence on the association between audit partner

tenure/rotation and audit quality is largely based on firm-level (rather than

partner-level) data, and the results are mixed. Furthermore, to our knowledge no

prior research distinguishes between engagement partner and review partner when

examining the effects of partner tenure and rotation.

While prior partner-level research is limited to information on engagement

partner switches, the current study draws on the unique opportunity to identify

individual engagement partner and review partner signatures in German audit

reports. Whereas some prior research suggests a negative effect of (excessive)

engagement partner tenure on audit quality (Chi and Huang 2005; Carey and

Simnett 2006) and other research shows a positive relationship (Chen et al. 2008;

Manry et al. 2008), we observe no significant association in our German data.

Similarly, while there is some extant evidence of a positive relationship between

engagement partner rotation and audit quality (Chi et al. 2009), rotation is not

associated with audit quality in the current study. Instead, review partner tenure is

34
in our study positively associated with audit quality, and review partner rotation is

associated with lower audit quality, inconsistent with the Taiwanese results by

Chi et al. (2009). A possible explanation for our observations is that review

partners‘ susceptibility to independence threats might be minimal because

involvement with the client is relatively limited, whereas review partner rotation

leads to a detrimental and visible loss in expertise. Meanwhile, expertise and

independence explanations might rule out each other for engagement partner

tenure and rotation.

Several caveats should be considered when interpreting the findings of this

study. First, our accrual measures are only an indirect proxy for audit quality. As

a result, a limitation in our study (as in most prior literature) is that the results are

potentially subject to measurement error problems. Second, our investigation of

whether accrual accounting performed by managers is a systematic occurrence

poses several challenges. In particular, we rely on the literature to develop models

of accrual determinants, and our inferences are dependent on the quality of these

models. Therefore, the empirical tests in the paper have to be interpreted as joint

tests of the quality of the set of economic determinants, the functional form of

accruals accounting models, and the theory related to audit quality. Third, as

shown in our descriptive results, partner tenure in Germany appears to be

consistently and considerably shorter than the mandated maximum of seven years.

As such, even with a period spanning from 1995 to 2010, with mandatory rotation

35
of key audit partners effective at the earliest in 2002, caution is recommended

when generalizing our results to the potential effects of mandatory rotation, since

other unobservable factors might influence the voluntary choice to switch prior to

the allowed maximum tenure. Overall short tenure might further be the reason for

the absence of observed tenure effects in the chosen sample, and rotation effects

might be weaker compared to other legislations.

We recommend future research to disentangle the effects of voluntary

versus mandatory audit partner rotation to specifically showcase the implications

of current mandatory requirements. Research exploring investor perceptions of

audit quality over a longer time horizon under the mandatory audit partner

rotation regime will be of particular interest because the perceived value of

mandatory audit partner rotation may well change when it becomes the standard.

Concluding, our results do not confirm the assumption implicit in rotation

policies that tenure reduces audit quality. We even provide some evidence against

the benefits of partner rotation, particularly for review partners. We suggest that

regulators should distinguish between the roles of key audit partners to ensure

adequate implementation of related requirements.

36
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42
TABLE 1
Data description

Data available in Compustat 1995-2010 9.597

Eliminated data with missing values 4.026
Available audit report data 2.636
Remaining Sample 2.636

43
TABLE 2
Summary statistics

Panel A: Frequency (percentage) of rotation (engagement

partner, review partner, firm partner) during sample period

n (%)
Engagement partner rotation 758 (28.76)
Review partner rotation 687 (26.06)
from engagement to review partner 124 (4.70)
from review to engagement partner 58 (2.20)
from review to engagement partner and engagement to
review partner 19 (0.72)
Simultaneous rotation of engagement and review partner 263 (9.98)
Audit firm rotation 228 (8.65)
with engagement partner rotation 189 (7.09)
with review partner rotation 199 (7.55)
with simultaneous rotation of engagement and review partner 174 (6.60)
without any partner rotation 24 (0.09)
and rotation from engagement to review partner 4 (0.15)
and rotation from review to engagement partner 5 (0.19)
and rotation from review to engagement partner and
engagement to review partner 1 (0.04)

44
TABLE 2 (Continued)

Panel B: Mean years of tenure (firm*, engagement partner,

review partner)

Variable Mean Median Std.dev.

Firm Tenure 5.23 4.00 3.3475
Engagement Partner Tenure 2.55 2.00 1.6193
Review Partner Tenure 2.80 2.00 1.7402
n=2.636
Firm Tenure 7.76 8.00 4.3404
Engagement Partner Tenure 3.36 3.00 1.8669
Review Partner Tenure 3.30 3.00 1.9223
n=299; DAX30
Firm Tenure 6.04 6.00 3.2498
Engagement Partner Tenure 2.78 2.00 1.7719
Review Partner Tenure 3.04 3.00 1.7079
n=487, MDAX
Firm Tenure 5.30 5.00 3.1141
Engagement Partner Tenure 2.57 2.00 1.5701
Review Partner Tenure 2.86 2.00 1.7616
n=303; TecDAX
Firm Tenure 5.46 5.00 3.6779
Engagement Partner Tenure 2.48 2.00 1.5553
Review Partner Tenure 2.75 2.00 1.8054
n=368; SDAX
Firm Tenure 4.53 4.00 2.9152
Engagement Partner Tenure 2.33 2.00 1.4935
Review Partner Tenure 2.62 2.00 1.6634
n=1.179; CDAX

Notes:
* Since we do not know for how long switching audit firms audited a given
company before 1995, the descriptive details cannot be interpreted as the real-
world mean of audit firm tenure.

45
TABLE 2 (Continued)

Panel C: Descriptive statistics for dependent measures and control variables

Variables Mean Median Std.dev. n

Primary variables
Cashflow Jones Accruals (CF-DACC) 0.00033 0.00153 0.10829 2,636
Absolute Cashflow Jones Accruals 0.06969 0.04204 0.08286 2,636
Positive Cashflow Jones Accruals 0.06852 0.03749 0.08583 1,347
Negative Cashflow Jones Accruals -0.07093 -0.04613 0.07966 1,289

Control variables
Firm Tenure 4.33763 4.00 2.88091
Big4 0.54590 1.0000 0.49798
Size 6.02916 5.837563 2.18880
Growth 0.08817 0.04884 0.45655
Cashflow 0.02445 0.03620 0.17545
Lifecycle 0.53586 0.03243 8.23201

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TABLE 3
Cashflow Jones discretionary accruals and engagement or review partner tenure

Absolute Positive Negative

Parameter CF-DACC CF-DACC CF-DACC
(1) (2) (3)
Intercept β0 0.2662206 0.0301837 -0.3675139
(3.16)*** (2.56)** (-4.78)***
EP Tenure β1 0.0011753 0.0019166 -0.0006579
(1.15) (1.35) (-0.47)
RP Tenure β2 -0.0017501 -0.0006667 0.0030131
(-1.73)* (-0.54) (1.95)*
Firm Tenure β3 -0.0012946 -0.0018153 0.0007258
(-2.07)** (-2.03)** (0.89)
Big4 β4 0.0001186 0.001291 -0.0015158
(0.04) (0.29) (-0.34)
Size β5 -0.0056451 -0.0034405 0.0083244
(-6.34)*** (-2.76)*** (6.82)***
Growth β6 0.018091 0.0190616 -0.0041201
(3.70)*** (3.42)*** (-0.65)
Cashflow β7 -0.0871874 -0.1965055 -0.0250186
(-4.54)*** (-7.91)*** (-0.91)
Lifecycle β8 0.000063 -0.0001713 -0.0015646
(0.21) (-2.90)*** (-3.91)***
Fixed industry and year
effects Included Included Included
adj. R-squared 0.1512 0.2623 0.1361
No. of observations 2,636 1,347 1,289

Notes:
All variables are winsorized at the 1% and 99% levels.
Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively.
*significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed)

47
TABLE 4
Cashflow Jones discretionary accruals and engagement or review partner rotation

Absolute Positive Negative

Parameter CF-DACC CF-DACC CF-DACC
(1) (2) (3)
Intercept β0 0.2639556 0.0306822 -0.3587317
(3.14)*** (2.65)*** (-4.61)***
EPS β1 -0.001742 -0.0038983 0.0023072
(-0.47) (-0.83) (0.44)
RPS β2 0.0080172 -0.0026696 -0.0166494
(2.06)** (-0.55) (-2.94)***
Firm Tenure β3 -0.0013099 -0.001673 0.0008718
(-2.20)** (-1.95)* (1.14)
Big4 β4 0.0000911 0.001306 -0.0016618
(0.03) (0.29) (-0.38)
Size β5 -0.0056443 -0.0033946 0.0083799
(-6.31)*** (-2.70)*** (6.87)***
Growth β6 0.0183621 0.0190721 -0.0049368
(3.77)*** (3.42)*** (-0.79)
Cashflow β7 -0.0870326 -0.1970091 -0.024554
(-4.54)*** (-7.94)*** (-0.90)
Lifecycle β8 0.0000682 -0.0001788 -0.0015584
(0.23) (-3.02)*** (-3.97)***
Fixed industry and year
effects Included Included Included
adj. R-squared 0.1519 0.2623 0.1412
No. of observations 2,636 1,347 1,289

Notes:
All variables are winsorized at the 1% and 99% levels.
Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively.
*significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed)

48
TABLE 5
Alternative measures of accruals and engagement or review partner tenure

Panel A: Absolute accruals

Absolute accruals
EP tenure RP tenure
Performance-matched model 0.00057 -0.00262
(0.40) (-1.81)*
Modified performance-matched model 0.00124 -0.00265
(0.86) (-1.83)*
Abnormal working capital accruals 0.00114 -0.00348
(0.67) (-2.02)**
Current accruals 0.00071 -0.00127
(0.46) (-0.79)

Panel B: Positive and negative accruals

Positive accruals Negative accruals

EP RP EP RP
tenure tenure tenure tenure
Performance-matched Model 0.00082 -0.00173 -0.00197 0.00298
(0.44) (-0.99) (-1.06) (1.53)
Modified performance-matched model 0.00084 -0.00108 -0.00270 0.00383
(0.45) (-0.64) (-1.45) (1.97)**
Abnormal working capital accruals 0.00136 0.00005 -0.00084 0.00477
(0.71) (0.03) (-0.35) (1.92)*
Current accruals 0.00047 -0.00025 -0.00251 0.00258
(0.26) (-0.14) (-1.28) (1.22)

Notes:
All variables are winsorized at the 1% and 99% levels.
Robust t-statistics and z-statistics clustered by firm are in parentheses, respectively.
*significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed)

49
TABLE 6
Alternative measures of accruals and engagement or review partner rotation

Panel A: Absolute accruals

Absolute accruals
EPS RPS
Performance-matched model 0.00070 0.01287
(0.14) (2.43)**
Modified performance-matched model -0.00133 0.01406
(-0.27) (2.60)***
Abnormal working capital accruals -0.00611 0.01784
(-1.07) (2.62)***
Current accruals -0.00159 0.01092
(-0.27) (1.76)*

Panel B: Positive and negative accruals

Positive accruals Negative accruals

EPS RPS EPS RPS
Performance-matched model 0.00021 0.00892 0.00501 -0.01090
(0.03) (1.22) (0.81) (-1.70)*
Modified performance-matched model 0.00054 0.00684 0.00857 -0.01514
(0.08) (0.95) (1.44) (-2.38)**
Abnormal working capital accruals -0.00764 -0.00179 0.00912 -0.02466
(-1.21) (-0.26) (1.11) (-2.47)**
Current accruals -0.00371 0.00207 0.00621 -0.01688
(-0.53) (0.32) (0.93) (-2.16)**

Notes:
All variables are winsorized at the 1% and 99% levels.
Robust t-statistics and z-statistics clustered by firm are in parentheses. respectively.
*significant at 10%; ** significant at 5%; *** significant at 1% (two-tailed)

50
TABLE 7
Correlation matrix

Engagement Review
partner partner
EPS RPS Tenure tenure tenure

EPS 1

RPS 0.2008 1
(0.0000)
Tenure 0.0606 0.082 1
(0.0035) (0.0001)
Engagement -0.5201 -0.0522 0.3401 1
Partner tenure (0.0000) (0.012) (0.0000)
Review -0.051 -0.4993 0.3395 0.4034 1
Partner tenure (0.0141) (0.0000) (0.0000) (0.0000)

51