The Length of Auditor-Client Relationships and Financial Statement Restatements

In this study, we examine associations between the length of auditor-client relationships and restatements of financial statements for non-GAAP accounting. We analyze a sample of public companies that announced restatements between January 1995 and October 2001, inclusive, and find that although there is no association between the length of auditor-client relationships and misstatements overall, audit firm tenure is significant for various important subsamples. Specifically, we find that clients are more likely to make income-increasing misstatements and to misstate core earnings the longer the auditor-client relationship. However, further analyses reveal that misstatements of quarterly, rather than annual, financial statements drive these results. To better understand the relationship between tenure and misstatements, we explore the role of auditor industry specialization and find that it is important, in that our results on the association between tenure and misstatements hold for non-specialist auditors but not for specialist auditors. We also find that although the auditor tenure is not a significant factor in the overall market reaction to restatement announcements, it does appear to play a role in restatement disclosures (in terms of attribution). Furthermore, tenure is important when considering the consequences of restatements, in terms of auditor turnover and market reactions to that turnover.