Large clients create an economic dependence that may cause auditors to compromise their independence and report favorably to retain valuable clients. Economic dependence is measured as a client's size relative to the size of the office that contracts for the audit and issues the audit report. We find no evidence economic dependence causes Big Five auditors to report more favorably for larger clients in their offices. However, larger clients also pose greater litigation risk, and we do find that Big 5 auditors report more conservatively for larger clients, suggesting that reputation protection dominates auditor behavior.

This study examines whether the length of the relationship between a company and an audit firm (audit‐firm tenure) is associated with financial‐reporting quality. Using two proxies for financial‐reporting quality and a sample of Big 6 clients matched on industry and size, we find that relative to medium audit‐firm tenures of four to eight years, short audit‐firm tenures of two to three years are associated with lower‐quality financial reports. In contrast, we find no evidence of reduced financial‐reporting quality for longer audit‐firm tenures of nine or more years. Overall, our results provide empirical evidence pertinent to the recurring debate regarding mandatory audit‐firm rotation — a debate that has, to date, relied on anecdotal evidence and isolated cases.

This study examines how using the internal audit function (IAF) as a management training ground (MTG) affects external audit fees and the external auditors' perceptions of the IAF. Over half of all companies that have an IAF specifically hire internal auditors with the purpose of rotating them into management positions (or cycle current employees into the IAF for a short stint before promoting them into management positions). Using archival data, we find that external auditors charge higher fees to companies that use the IAF as a MTG. Using an experiment, we provide evidence as to why fees are higher. Specifically, we find that external auditors perceive internal auditors employed in an IAF used as a MTG to be less objective but not less competent than internal auditors employed in an IAF not used as a MTG. These results have important implications for the many companies that use their IAF as a MTG. Data Availability: Contact the authors. Data provided by the Institute of Internal Auditors Research Foundation are subject to restrictions.