Audit firm-client relationship: influence of audit firm tenure and audit firm switching on the audit quality of client firms in Italy

Abstract

The study analyses whether the implementation of mandatory audit firm rotation positively contributes to the level of audit quality. Erosion in auditors’ independence as a result of a long audit firm-client relationship is perceived as cause for a lower audit quality. The focus is on Italian listed companies for whom mandatory audit firm rotation is effective for more than 30 years. As a consequence, client firms can switch audit firm after a three-year engagement and the relationship can be extended twice with a maximum number of nine years. Due to this specific regulation, this study is able to determine whether a longer audit firm tenure influences audit quality and whether a switch in audit firm has its effect on the audit quality of client firms. Two measures examine the level of audit quality: the amount of discretionary accruals and the amount of abnormal working capital accruals. The amount of discretionary accruals and the amount of negative abnormal working capital accruals reject that audit quality will decrease, when audit firm tenure extends. However, the findings do not provide evidence of an association between audit firm switching and the amount of both discretionary accruals and abnormal working capital accruals.