Accounting Horizons

Vol. 22, No. 3 American Accounting Association

2008 DOI: 10.2308/acch.2008.22.3.297
pp. 297–314

Auditor Tenure and Shareholder Ratification

of the Auditor
Mai Dao, Suchismita Mishra, and K. Raghunandan

SYNOPSIS: Legislators and regulators have expressed concerns about the effect of
long auditor tenure on audit quality. There is little direct evidence on investors’ percep-
tions about long auditor tenure. In this paper, we use shareholder votes on auditor
ratification as a proxy for investor perceptions about audit quality. We find, using data
from 635 firms during 2006, that shareholder votes against 共or abstaining from兲 auditor
ratification are positively correlated with auditor tenure. The results suggest that share-
holders view long auditor tenure as adversely affecting audit quality, and provide an
empirical basis for arguments related to the impact of long auditor tenures on share-
holders’ perceptions of audit quality.

INTRODUCTION

C
oncerns about the impact of long-term auditor-client relationships on auditor indepen-
dence, and thus on audit quality, have been raised by legislators and regulators for many
years 共e.g., U.S. Senate 1976, 1977; SEC 1994, 1999兲. Such concerns have received
renewed attention from legislators and the media following the series of accounting scandals in the
early 2000s 共Norris 2002; U.S. Senate 2002兲. Reflecting such views, Section 207 of the Sarbanes-
Oxley Act, or SOX 共U.S. House of Representatives 2002兲, requires the U.S. Comptroller General
to conduct a study on the potential impacts of mandatory audit firm rotation.
Supporters of mandatory auditor rotation suggest that long auditor tenure may impair auditor
independence and audit quality; therefore, if auditor firms are rotated, the new auditor will bring
a “fresh look” at clients’ financial statement reporting and improve audit quality 共Brody and
Moscove 1998; Byrnes et al. 2002兲. Opponents of mandatory rotation argue that because of high
audit start-up costs and increased risk of audit failures, audit quality is likely to be lower in the
early years of audit engagements 共AICPA 1978; Dye 1991; Geiger and Raghunandan 2002兲.
Some recent studies have examined the association between auditor tenure and a variety of
financial reporting related measures, including fraudulent financial reporting 共Carcello and Nagy
2004兲, quality of reported earnings 共Johnson et al. 2002; Myers, Myers, and Omer 2003; Davis et
al. 2007; Gul et al. 2007兲, and the likelihood of auditors issuing going-concern opinions 共Geiger
and Raghunandan 2002; Choi and Doogar 2005; Knechel and Vanstraelen 2007兲. In general, the

Mai Dao is a Ph.D. Student, Suchismita Mishra is an Assistant Professor, and K. Raghunandan is a Profes-
sor, all at Florida International University.

We thank Dana Hermanson and two anonymous reviewers for many helpful comments on earlier versions of this paper.
Submitted: August 2007
Accepted: April 2008
Published Online: September 2008
Corresponding author: K. Raghunandan
Email: raghu@fiu.edu
297
298 Dao, Mishra, and Raghunandan

empirical evidence from such studies does not support the proposition that long auditor tenure is
associated with reduced audit quality. Notwithstanding such empirical evidence, critics continue to
suggest 共usually based on anecdotal evidence兲 that mandatory auditor rotation is needed to en-
hance investor protection 共e.g., Feder 2003; Nocera 2005; Norris 2006兲.
Given the divergence between the empirical evidence and the periodic assertions by legisla-
tors and others about the need for mandatory auditor rotation, what are the perceptions of investors
about long auditor tenures? There is little direct evidence on whether investors believe long
auditor tenure adversely affects auditor quality.1 In this paper, we fill this void in the literature and
examine investors’ perceptions about the association between long auditor tenure and audit quality.
We measure shareholders’ perceptions through their voting on auditor ratification.
Evidence from experimental settings suggests that investor involvement in auditor selection
enhances the independence of the auditor and, thus, audit quality 共Mayhew and Pike 2004兲.
Although there is no legal requirement for public companies to submit the selection of the external
auditor for ratification by shareholders, many do so as a matter of good corporate governance
共Krishnan and Ye 2005兲. Some recent empirical studies have used the proportion of shareholders
not voting to ratify the auditor as a measure of investor perceptions about audit quality 共e.g.,
Raghunandan 2003; Mishra et al. 2005兲. In a similar vein, our hypothesis is that if investors
believe long auditor tenures are likely to reduce audit quality, then the proportion of shareholders
voting against auditor ratification should be higher when the auditor has a long tenure with the
client.
We use shareholder voting data during 2006 for 635 companies covered by the Board Analyst
database. We find that shareholders are more likely to vote against, or abstain from, auditor
ratification when the auditor has long tenure with the client.
The remainder of the paper is organized as follows. The next section provides background and
develops the hypothesis. This is followed by descriptions of the research method and data. Results
are presented next, and the final section provides a summary and conclusions.

BACKGROUND AND HYPOTHESIS

Auditor Tenure and Perceptions of Audit Quality
Legislators, regulators, and others have periodically discussed the issue of long-term auditor-
client relationships and their influence on auditor independence and audit quality. Critics suggest
that the auditor could become less skeptical over time with a client. For example, Mautz and
Sharaf 共1961, 208兲 note that “the greatest threat to his 共the auditor’s兲 independence is a slow,
gradual, almost casual erosion of his ‘honest disinterestedness.’” Proponents of mandatory auditor
rotation suggest that because the incentives associated with keeping a particular client are fewer
共given the shorter time horizon兲, and because another audit firm would be reviewing the work
within a specified period, auditors “might be less likely to succumb to management pressure”
共General Accounting Office 关GAO兴 2003兲.
More than a quarter century before SOX, the Metcalf Committee report 共U.S. Senate 1976兲
expressed concerns about the effects of long tenure on auditor judgments. The report noted:
Long association between a corporation and an accounting firm may lead to such close identification of
the accounting firm with the interests of its client’s management that truly independent action by the
accounting firm becomes difficult. One alternative is mandatory change of accountants after a given
period of years. 共U.S. Senate 1976, 21兲

1
Ghosh and Moon 共2005兲 examine the impact of auditor tenure on the association between reported earnings and market
returns 共i.e., earnings response coefficient兲.

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Periodically, the Securities and Exchange Commission 共SEC兲 has expressed concerns about
the possible adverse effects from long auditor tenures 共SEC 1994, 1999兲. The SEC 共2001兲, in an
enforcement release that prohibited five Andersen partners involved in the audits of Waste Man-
agement from auditing public companies, summarized another argument advanced by advocates of
auditor rotation as follows. An auditor may initially overlook or accept an accounting treatment
because the amounts are immaterial; however, the same treatment may be repeated over time and
the auditor may find it difficult to tell the client to refrain from doing something that the same
auditor accepted in earlier years.2
In the congressional hearings that followed the failure of Enron and Andersen, considerable
attention was paid to the association between auditor tenure and audit quality 共U.S. Senate 2002兲.
Congress did not legislate mandatory auditor rotation, but Section 207 of SOX requires the GAO
to study the potential impacts of mandatory auditor rotation.
Opponents of mandatory auditor rotation argue as follows. Effective audits require a thorough
understanding of the client’s business and processes; such understanding develops over time, and
there is a learning curve that lasts a year or more; hence, audit quality is likely to be lower in the
initial years of an audit 共GAO 2003兲. In addition, the disruption to the client caused by auditor
rotation leads to nontrivial commitment of resources 共personnel and financial兲 in educating the
auditor about the client’s operational and accounting matters.

Research Related to Auditor Tenure

The appendix provides a list of papers that have examined issues related to auditor tenure. As
can be seen from the appendix, prior studies have used a variety of dependent variables, including
different abnormal accruals measures, ability to meet or beat earnings forecasts, earnings response
coefficients, stock and debt rankings, SEC enforcement actions, financial statement restatements,
occurrence of fraud, litigation against auditors, and going-concern opinions. Some studies have
used surveys of audit committee members and financial executives. The empirical evidence from
the majority of such studies is “consistent with the hypothesis that audited financial statements …
are perceived as more reliable for firms with longer auditor tenure” 共Ghosh and Moon 2005, 609兲.
Finally, the GAO, as part of its study of auditor tenure pursuant to the mandate of Section 207 of
SOX, also conducted a survey of large public accounting firms and the Fortune 1000 companies.
The GAO’s 共2003兲 report concluded that mandatory audit firm rotation might not be the most
efficient way to improve auditor independence and audit quality.

Shareholder Perceptions of Audit Quality and Voting on Auditor Ratification

Investors’ perceptions of audit quality are important because such perceptions can in turn
affect their confidence related to the reliability of financial statements; investor confidence is a
necessary underpinning for strong and vibrant capital markets. For example, the SEC 共2000a兲
notes:
If investors do not believe that the auditor is truly independent from the issuer, they will derive little
confidence from the auditor’s opinion and will be far less likely to invest in the issuer’s securities.
Fostering investor confidence, therefore, requires not only that auditors actually be independent of their
audit clients, but also that reasonable investors perceive them to be independent. 共SEC 2000a兲

2
The SEC 共2001兲 noted that “the auditor ultimately will find itself in an untenable position: it either must continue issuing
unqualified audit reports on materially misstated financial statements and hope that its conduct will not be discovered or
it must force a restatement or qualify its report and thereby subject itself to the liability that likely will result from the
exposure of its role in the prior issuance of the materially misstated financial statements.”

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300 Dao, Mishra, and Raghunandan

Prior to SOX, client managements had significant influence over the selection of the auditor
共Mayhew and Pike 2004兲. In many instances, auditors were selected by management, whereas in
other companies audit committees were involved in the auditor selection process. Section 301 of
SOX changed the auditor selection process, and stated that the audit committee “shall be directly
responsible for the appointment, compensation, and oversight” of the independent auditor. Even
after this change, no legal requirements have been made for direct shareholder participation in the
auditor selection process. Nevertheless, many companies voluntarily ask for a shareholder ratifi-
cation vote presumably as a matter of good corporate governance practice 共Krishnan and Ye 2005兲
and also in response to recent demands from some institutional investors for such a vote.
Corporate governance activists have recently demanded that audit committees give sharehold-
ers such a vote 共Baue 2003兲. The Chief Counsel at Institutional Shareholder Services 共ISS兲, a
leading provider of proxy voting and corporate governance services, notes that “companies have
accepted the fact that people want that choice … it gives shareholders their only opportunity to
comment on the outside audit” 共Marshall 2005兲. Some large institutional investors such as CalP-
ERS, TIAA-CREF, and AFL-CIO include the 共lack of兲 opportunity for shareholders to ratify the
auditor selection as a criterion used in the evaluation of governance practices and have started to
vote against audit committee directors of companies that do not submit the auditor for ratification
by shareholders 共Taub 2004; Wolf 2006兲.

Research Related to Shareholder Ratification of the Auditor

Research related to shareholder voting on auditor ratification is relatively sparse. Mayhew and
Pike 共2004兲 examine, in an experimental setting, the influence of letting shareholders select the
auditor. Their experiment was conducted prior to SOX, so their setting does not directly corre-
spond with SOX’s requirements for audit committees to select the auditor. Nevertheless, Mayhew
and Pike 共2004兲 show that placing the hiring of the auditor under the control of investors leads to
fewer independence violations and substantially improves auditor independence.
Krishnan and Ye 共2005兲 examine why some firms do or do not submit auditor selection for a
ratification vote by shareholders. They show that high nonaudit fees increase the likelihood that a
company will seek shareholder approval on auditor selection, but that shareholder dissatisfaction
with the board is negatively associated with the likelihood of seeking ratification.
SEC registrants were required to disclose nonaudit fee ratios 共but not the dollar amounts of
audit or nonaudit fees兲 from 1979 to 1981 pursuant to the requirements of ASR No. 250. Using
such nonaudit fee ratio data, Glezen and Millar 共1985兲 find no association between the nonaudit
fee ratio and the proportion of shareholders ratifying the auditor selected by management. Sainty
et al. 共2002兲 show that the proportion of votes against auditor selection in 1997 is 共1兲 negatively
associated with stock returns and institutional ownership, 共2兲 positively related to the issuance of
going-concern opinions, and 共3兲 lower for Big 6 firms.
As part of the revision of auditor independence rules, the SEC 共2000b兲 required registrants to
disclose—in proxy statements filed on or after February 5, 2001—details about fees paid to the
auditor; later, in 2003, as part of the revision of the independence rules following the enactment of
SOX, the SEC changed the fee disclosure regulations and now requires such fee disclosure in
10-Ks filed with the Commission. The SEC 共2000a, 2000b, 2003兲 justified the fee disclosure
requirements by stating that information about the fees paid to the auditor “may help shareholders
decide, among other things, how to vote their proxies in selecting or ratifying management’s
selection of an auditor.” Two recent studies have tested the SEC’s assertions by examining the
association between nonaudit fees and shareholder ratification of the auditor. Raghunandan 共2003兲
shows that the proportion of shareholders not voting to ratify the auditor in 2001 is higher in
companies that reported higher nonaudit fee ratios. Mishra et al. 共2005兲 employ the expanded fee

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Auditor Tenure and Shareholder Ratification of the Auditor 301

categories used by companies in their SEC filings after FRR No. 68 was issued in 2003, and find
that the proportion of shareholders voting against auditor ratification is positively related to both
the tax and “other” nonaudit fee ratios but not the audit-related fee ratio.

Hypothesis
Some recent empirical studies suggest that audit quality is lower in the initial years of an
auditor-client relationship, and that audit quality does not deteriorate with longer auditor tenure.
Yet, many critics continue to suggest that audit quality declines with long auditor tenures. Recent
empirical evidence also indicates that shareholder perceptions about auditor independence—and
hence, audit quality—are associated with the auditor ratification vote. If shareholders perceive—
rightly or wrongly—that long auditor tenure would indeed have a negative effect on audit quality,
then the proportion of shareholders voting against auditor ratification should be higher in the
presence of long auditor tenures. Conversely, if shareholder perceptions are consistent with the
weight of the evidence from recent research related to the effects of auditor tenure on audit quality,
we should find that voting against auditor ratification should be lower as auditor tenure increases.
Ultimately, this is an empirical issue, and we provide some relevant empirical evidence for the
debate. Thus, our hypothesis is in the null form:
H1: The proportion of shareholders voting against, or abstaining from, auditor ratification is
not associated with auditor tenure.
We focus on the proportion of votes against, and abstaining from, auditor ratification because
abstentions are not discarded as nonvotes in shareholder ratification of the auditor 共Raghunandan
2003兲. In addition, our approach is also consistent with that used in prior research related to
shareholder ratification of the auditor.

METHOD
We examine the association between auditor tenure and shareholder voting on auditor ratifi-
cation using the following multiple regression model:
Log共VOTE兲 = ␤0 + ␤1*Log共TotalAssets兲 + ␤2*InsiderOwnership + ␤3*BlockOwnership

+ ␤4*InstnlOwnership + ␤5*CEOCHR + ␤6*ROA + ␤7*RETURN

+ ␤8*NASRatio + ␤9*DirectorVote + ␤10*Big4 + ␤11*Log共Tenure兲 + error.

The variables are defined as follows:

Log共VOTE兲 ⫽ natural logarithm of the percent of votes against or abstaining from auditor
ratification;
Log共TotalAssets兲 ⫽ natural logarithm of total assets;
InsiderOwnership ⫽ proportion of shares held by officers and directors;
BlockOwnership ⫽ proportion of shares held by block-holders 共owing 5 percent or more兲;
InstnlOwnership ⫽ proportion of shares held by institutions;
CEOCHR ⫽ 1 if the CEO also serves as Chair of the Board, 0 otherwise;
ROA ⫽ return on assets 共net income divided by total assets兲;
RETURN ⫽ one year common stock return;
NASRatio ⫽ ratio of nonaudit fees to audit fees;
DirectorVote ⫽ minimum percent of the votes against the election of a director;
Big4 ⫽ 1 if the auditor is a Big 4 audit firm, 0 otherwise; and
Log共Tenure兲 ⫽ natural logarithm of auditor tenure 共in years兲.

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302 Dao, Mishra, and Raghunandan

In the regression model, Log共VOTE兲, is the dependent variable and is used as the proxy for
investor perceptions of audit quality. We use the log-transformed variable because the VOTE
variable is highly skewed, and hence the results from any Ordinary Least-squares 共OLS兲 regres-
sion may be misleading; furthermore, the VOTE variable is truncated at a minimum value of zero,
and as such, may not be amenable to OLS regression.3
Company size, measured by Log共TotalAssets兲, is included in the model as a control variable
for the following reasons. First, governance activists generally pay more attention to large firms
and are more likely to target larger firms for symbolic votes against management 共Bethel and
Gillan 2000兲. Second, firm size is used as a control variable for a variety of reasons in most
accounting and auditing research. We expect the coefficient of Log共TotalAssets兲 to be positive in
the regression.4
Prior research 共Raghunandan 2003; Mishra et al. 2005兲 suggests that ownership characteris-
tics influence shareholder voting on auditor ratification. Agency theory suggests that the greater
the extent of ownership by managers, the higher the alignment of interests between owners and
managers. We include InsiderOwnership and expect the coefficient of this variable to be negative.5
The extent of ownership by block-holders and institutions may affect shareholder voting, so
corporate-governance-related research typically also includes blockholdings and institutional own-
ership as control variables. We include BlockOwnership and InstnlOwnership as control variables
in the regression.
Following prior research, we also include CEOCHR as a corporate-governance-related control
variable. The Board is supposed to provide monitoring over the CEO. If the same individual holds
both the CEO and Chair of the Board positions, then it is likely that investors will have lower
confidence in one source of monitoring; this in turn should increase the importance of a high
quality audit. We expect shareholders to be more active if the CEO also serves as the Chair of the
Board, and expect the coefficient of CEOCHR to be positive in the regression.
We control for company performance with two measures. The first, ROA 共return on assets兲, is
an accounting-based measure while the second, RETURN, is a market-based measure. Prior stud-
ies find that the support for management proposals is weaker at poorly performing firms 共Gordon
and Pound 1993; Gillan and Starks 2000兲, so we expect the coefficients on ROA and RETURN to
be negative.
Raghunandan 共2003兲 and Mishra et al. 共2005兲 find that shareholder voting on auditor ratifi-
cation is associated with the nonaudit fee ratio. Accordingly, we include NASRatio as a control
variable and expect the coefficient to be positive in the regression.6

3
As part of our additional tests, we also used two other measures: VOTE itself, and a rank-transformed variable. Results
from both of these variables are quite similar to those presented in Table 3, and the Log共Tenure兲 variable continues to
remain significant in the regression. Finally, as in Sainty et al. 共2002兲, we keep only those firms in the top and bottom
deciles of investor dissatisfaction; again, our results with respect to the independent variables are quite similar to those
reported in the paper.
4
We also used alternative size measures such as sales or market value; results with such alternative measures are
substantively similar to those reported in the paper.
5
Insiders are unlikely to cast votes against auditor ratification. Hence, we use an alternative measure that subtracts insider
shareholdings from the denominator 共total number of shares outstanding兲 in the calculation of VOTE and drop
InsiderOwnership as a control variable. Results with this alternative specification are similar to those presented in the
paper, and the Log共Tenure兲 variable continues to remain significant 共p ⬍ 0.01兲 in the regression.
6
Mishra et al. 共2005兲 examine data from fiscal 2002 and find that investors’ reactions differ for different types of nonaudit
fees. Our analysis covers a much later time period, and firms are in general much less likely to purchase nonaudit
services from their auditors in the post-SOX period; whereas Mishra et al. 共2005兲 report average nonaudit fee ratio of
1.24, the corresponding ratio for our sample is only 0.25. Hence, to keep the model parsimonious, we do not use three
separate fee ratios. However, when we use three separate fee ratios, consistent with Mishra et al. 共2005兲 we find that the
tax fee ratio and other fee ratio 共but not the audit related fee ratio兲 are positive and significant in the regression.

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Some shareholders may be likely to vote against all management proposals, including auditor
ratification 共Raghunandan 2003兲. We include DirectorVote to control for such “vote NO on all
management proposals” positions and expect that the coefficient on this variable will be positive
in the regression.
Audit firm size is usually used as a surrogate for auditor quality. Consistent with most prior
research in auditing, we include membership in the Big N 共Big4兲 as a surrogate for audit quality
and expect this variable to be negative in the regression.
The variable of interest for our study is Log共Tenure兲. If shareholders perceive that audit
quality decreases with auditor tenure, then the coefficient of this variable should be positive in the
regression. The overall results are substantively similar if we use the square-root transformed
measure of auditor tenure instead of the logarithmic transformation.

Data
We obtained our initial sample from the 2006 version of Corporate Library’s Board Analyst
database.7 We selected all 2,084 domestic firms with fiscal year ending December 31, 2005. Given
the recent rapid changes in the accounting and auditing environment, and the fact that 2005
represented only the second year of SOX 404, we restricted the analysis to firms with a December
31 fiscal year end.
As noted in Table 1, Board Analyst provides auditor tenure data for 743 of the 2,084 firms. We
expanded the sample as follows. Given the difficulty of hand-collecting voting data, we alphabeti-

TABLE 1
Sample Selection

U.S. Firms with Fiscal Year Ended 12/31/2005 in Board Analyst and Compustat 2,084
Less:
Firms not selected for analysis 共see note below兲 共1,117兲
Auditor change in 2006 共69兲
Did not submit auditor selection for ratification vote 共194兲
Missing vote or other financial data 共69兲
Final sample 635

The Board Analyst database provides auditor tenure data for 743 of the 2,084 U.S. firms with fiscal year ending December
31, 2005. We expanded the sample by alphabetically sorting the other 1,341 firms, and then taking every 6th firm in the list;
this resulted in an additional 224 firms being selected 共or, the deletion of 1,117 firms兲.

7
The Board Analyst database covers “all public companies of the S&P 500, S&P MidCaps 400, S&P SmallCaps 600,
Fortune 1000 and Russell 3000” 共Corporate Library 2007兲. This database provides information about a variety of
measures related to corporate governance, CEOs, and directors.

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304 Dao, Mishra, and Raghunandan

cally sorted the other 1,341 firms, and took every 6th firm in the list.8 This procedure resulted in
an additional 224 firms being included in the sample.
From this list of 967 firms, we deleted 69 firms that changed auditors in 2006. Of the
remaining 898 firms, 194 did not submit auditor selection for a shareholder ratification vote. Thus,
the proportion of firms voluntarily submitting auditor selection for ratification is 78 percent
共704 / 898兲, which is significantly higher 共p ⬍ 0.05兲 than the proportions reported in some prior
studies examining shareholder ratification of the auditor 共61 percent in both Raghunandan 2003
and Mishra et al. 关2005兴; 68 percent in Krishnan and Ye 关2005兴兲, and supports anecdotal evidence
that some governance activists are pressuring companies to submit auditor selection for share-
holder ratification vote 共Baue 2003; Marshall 2005兲.
We obtained financial data from Compustat, governance data from Board Analyst or from
company filings available at the SEC website, and institutional ownership data from the Thomson
Financial database. Details of shareholder votes on auditor and director ratification were manually
collected from 10-Qs and 8-Ks available at the SEC website. After deleting 69 observations with
missing data, our usable sample consists of 635 firms.

RESULTS
Table 2 presents descriptive data about the variables. The mean 共median兲 proportion of share-
holders voting against auditor ratification 共VOTE兲 is 1.63 共1.05兲 percent. This number is in line
with the numbers reported in some recent studies, and suggests that in general shareholders are
happy with 共or, at least not unhappy enough to vote against兲 the selected auditor. In 40 of the
firms, the proportion is greater than 5 percent.
The mean and median total assets for the sample firms are $10.07 billion and $1.16 billion
respectively, indicating that the sample is skewed. Insiders and block-holders own 14 and 21
percent of the shares, respectively. The median sample firm is profitable with an ROA of 0.04. Of
these companies, 63 percent have the CEO as the Chair of the Board. The mean 共median兲 of the
minimum percent of shareholder votes against director ratification is 2.18 percent 共1.35 percent兲.9
The average nonaudit fee ratio is only 0.24; this is much lower than the numbers reported in some
earlier studies of shareholder ratification of the auditor that examined periods immediately before
or after SOX, and suggests that, as the effects of SOX and related initiatives fully take effect,
auditors are unlikely to be used for significant nonaudit services by most SEC registrants.
While we do not include a correlation matrix, we find that none of the Pearson correlations
involving the independent variables exceed 0.4, suggesting that multicollinearity is unlikely to be
a problem. This inference is confirmed later by an examination of VIF scores, none of which
exceeds 2.

Regression Results
Table 3 provides the regression results for the model with Log共VOTE兲 as the dependent
variable 共model 1兲. The overall model is statistically significant 共p ⬍ 0.001兲, and the model ex-

8
We obtained auditor tenure data for the other 1,341 firms from Compustat. However, our confidence in the auditor
tenure data from Compustat is lower than in the case of data from Board Analyst. In addition to having more errors,
Compustat truncates the auditor hiring years at 1974 for Big 8 auditors and at 1988 for specific non-Big 8 auditors. 共This
also is the reason we selected all 743 firms with available tenure data from Board Analyst first.兲 Hence, as a sensitivity
test we restrict the analysis to only those firms with auditor tenure data from Board Analyst. The overall inference about
the association between auditor tenure and shareholder voting remains unchanged when we restrict the analysis to the
subsample with tenure data from Board Analyst.
9
It is interesting that these numbers are higher than the corresponding values for votes related to auditor ratification,
suggesting that shareholders distinguish between director elections and ratification of the auditor.

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TABLE 2
Descriptive Statistics
Standard 25th 75th
Variable Mean Deviation Percentile Median Percentile

VOTE 1.63 1.93 0.35 1.05 2.20

TotalAssets 共$MM兲 10,070.67 65,032.57 331.05 1,161.16 4,424.97
Log共TotalAssets兲 20.99 1.80 19.60 20.86 22.21
InsiderOwnership 0.14 0.16 0.03 0.07 0.18
BlockOwnership 0.21 0.16 0.08 0.19 0.31
InstnlOwnership 0.75 0.19 0.64 0.81 0.92
CEOCHR 0.63 0.48 0.00 1.00 1.00
ROA 0.02 0.13 0.01 0.04 0.07
RETURN 0.03 0.39 ⫺0.19 0.01 0.22
NASRatio 0.24 0.27 0.06 0.16 0.31
DirectorVote 2.18 2.83 0.56 1.35 2.42
Big4 0.88 0.32 1.00 1.00 1.00
Log共Tenure兲 2.12 0.90 1.61 2.20 2.77

Variable Definitions:
VOTE ⫽ percent of votes against or abstaining from auditor ratification;
Log共TotalAssets兲 ⫽ natural logarithm of total assets;
InsiderOwnership ⫽ proportion of shares held by officers and directors;
BlockOwnership ⫽ proportion of shares held by block-holders 共owing 5 percent or more兲;
InstnlOwnership ⫽ proportion of shares held by institutional owners;
CEOCHR ⫽ 1 if the CEO also serves as chair of the board, 0 otherwise;
ROA ⫽ return on assets 共net income is divided by total assets兲;
RETURN ⫽ one-year common stock return;
NASRatio ⫽ ratio of non-audit fees to audit fees;
DirectorVote ⫽ minimum percent of the votes against the election of a director;
Big4 ⫽ 1 if the auditor is a Big 4 audit firm, 0 otherwise; and
Log共Tenure兲 ⫽ natural logarithm of auditor tenure 共in years兲.

plains about 32 percent of the variation in the dependent variable. The coefficient of
Log共TotalAssets兲 is positive and marginally significant, indicating that larger companies in general
are likely to have more shareholder votes against auditor ratification. The coefficients for
InsiderOwnership and BlockOwnership are negative and significant. The coefficient for NASRatio
and DirectorVote are both positive and significant, and reinforce the results from other recent
papers that have examined shareholder ratification of the auditor. The coefficient for the variable
of interest, Log共Tenure兲, is positive and significant 共p ⬍ 0.01兲. This indicates that shareholders are
more likely to vote against or abstain from ratifying management’s auditor selection if the nomi-
nated auditor has been the auditor of record for a long period.
Table 3 also presents the results from another model, where we use the Tenure variable
without the logarithmic transformation 共model 2兲. Overall, the results are quite similar, and once
again the results indicate that long auditor tenures are more likely to be associated with a higher
proportion of shareholders voting against or abstaining from auditor ratification.

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306 Dao, Mishra, and Raghunandan

TABLE 3
Regression Results

Log共VOTE兲 = ␤0 + ␤1 * Log共TotalAssets兲 + ␤2 * InsiderOwnership + ␤3 * BlockOwnership

+ ␤4 * InstnlOwnership + ␤5 * CEOCHR + ␤6 * ROA + ␤7 * RETURN + ␤8 * NASRatio

+ ␤9 * DirectorVote + ␤10 * Big4 + ␤11 * Log共Tenure兲 + error

Model 1 Model 2 Model 3

Coefficient Coefficient Coefficient
Variable (p-value) (p-value) (p-value)
Intercept ⫺1.847 ⫺1.399 ⫺1.260
共0.003兲 共0.031兲 共0.046兲
Log共TotalAssets兲 0.053 0.048 0.065
共0.056兲 共0.091兲 共0.019兲
InsiderOwnership ⫺2.694 ⫺2.651 ⫺2.705
共⬍0.001兲 共⬍0.001兲 共⬍0.001兲
BlockOwnership ⫺1.574 ⫺1.531 ⫺1.560
共⬍0.001兲 共⬍0.001兲 共⬍0.001兲
InstnlOnwership 0.015 0.001 ⫺0.001
共0.941兲 共0.971兲 共0.814兲
CEOCHR ⫺0.001 ⫺0.019 ⫺0.003
共0.990兲 共0.836兲 共0.974兲
ROA ⫺0.162 ⫺0.249 ⫺0.100
共0.651兲 共0.496兲 共0.780兲
RETURN ⫺0.054 ⫺0.056 ⫺0.063
共0.630兲 共0.623兲 共0.573兲
NASRatio 0.816 0.825 0.802
共⬍0.001兲 共⬍0.001兲 共⬍0.001兲
DirectorVote 0.062 0.064 0.062
共⬍0.001兲 共⬍0.001兲 共⬍0.001兲
Big4 0.126 0.396 0.065
共0.403兲 共0.007兲 共0.690兲
Log共Tenure兲 0.395 — —
共⬍0.001兲
Tenure 0.019 —
共⬍0.001兲
ShortTenure ⫺0.487
共⬍0.001兲
LongTenure 0.472
共⬍0.001兲

(continued on next page)

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Auditor Tenure and Shareholder Ratification of the Auditor 307

TABLE 3 (continued)

Model 1 Model 2 Model 3

Coefficient Coefficient Coefficient
Variable (p-value) (p-value) (p-value)

F stat. = 26.8, F stat. = 23.6, F stat. = 25.2,

p ⬍ 0.001; p ⬍ 0.001; p ⬍ 0.001;
Adj. R2 = 0.32 Adj. R2 = 0.28 Adj. R2 = 0.31

The sample includes 635 firms selected as noted in Table 1. p-values are two-tailed.
Variable Definitions:
Log共Vote兲 ⫽ natural logarithm of percent of votes against or abstaining from auditor ratification;
Tenure ⫽ auditor tenure 共in years兲;
ShortTenure ⫽ 1 if auditor tenure is less than 4 years, 0 otherwise; and
LongTenure ⫽ 1 if auditor tenure is more than 9 years, 0 otherwise.

Other variables are defined as in Table 2

Three-Way Tenure Analysis

Davis et al. 共2007兲 find that firms with both short and long tenure are more likely to have
discretionary accruals that allow them to meet or beat earnings forecasts. Along these lines, in a
survey by Knapp 共1991兲, audit committee members believed that audit quality increased in the
initial years of an auditor’s tenure, but then declined after a turning point was reached. We address
whether shareholder voting on auditor ratification reflects such a nonmonotonic relationship with
auditor tenure. We partition the sample into three groups based on auditor tenure: short tenure 共less
than four years兲, medium tenure 共between four to nine years兲, and long tenure 共10 or more years兲.
We then use two dummy variables: ShortTenure 共1 if short tenure, 0 otherwise兲 and LongTenure
共1 if long tenure, 0 otherwise兲 instead of the continuous variable for auditor tenure 共Log共Tenure兲兲
in the regression model discussed earlier. Thus, we compare the votes against auditor ratification
of the short and long tenure groups relative to the medium tenure group.
The last column of Table 3 presents the results from a regression with two dummy variables
for short and long auditor tenures 共model 3兲. The coefficient of ShortTenure is negative and
significant 共p ⬍ 0.01兲 but the coefficient of LongTenure is positive and significant 共p ⬍ 0.01兲.
This indicates that shareholders were less 共more兲 likely to vote against, or withhold from, auditor
ratification in the initial 共later兲 years of an auditor’s tenure. Thus, the relationship between auditor
tenure and shareholder voting on auditor ratification appears to be monotonic.

Additional Analyses
Many prior studies in accounting and auditing document significant differences between the
Big N and other firms along a variety of dimensions. Hence, as part of our sensitivity analyses, we
separately examine the Big 4 and non-Big 4 clients. We find that our primary result—shareholders
are more likely not to vote for auditor ratification when there is long auditor tenure—holds in both
the Big 4 and non-Big 4 subsamples. In addition, we separately examine the clients of each of the
Big 4 audit firms. In each of the four subsamples, we find that shareholders are more likely to vote
against or abstain from auditor ratification for long-tenured clients.

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308 Dao, Mishra, and Raghunandan

Our sample includes former clients of Andersen that were forced to switch auditors in 2002.
Some recent studies find that former Andersen clients were treated differently than continuing
clients by the successor auditors 共Cahan and Zhang 2006; Krishnan et al. 2007兲. Hence, we drop
all former clients of Andersen and re-perform the analysis; we find that the results from this
subgroup are quite similar to those reported in Table 3.
Block-holders have significant influence on voting issues, and hence can be expected to be
active in shareholder voting issues. To ensure that block-holders are not driving the results, we
perform the following test. From the reported voting data alone, it is not possible to identify
whether a significant block-holder共s兲 voted against auditor ratification. Since the SEC requires
block-holding disclosure only when the investor owns 5 percent or more of the shares, we deleted
40 observations where the vote against the auditor was more than 5 percent. Then, we dropped the
block-holding variable from the regression model. The results with respect to the other variables
are quite similar, and the Log共Tenure兲 variable continues to remain significant at p ⬍ 0.01.10
As noted earlier, consistent with prior research and the regulatory requirements related to
shareholder voting, we use both the votes against auditor ratification and the votes withheld for
auditor ratification in our analyses. As an alternative measure, we use only the votes against
auditor ratification—and exclude the withheld votes from the analyses. The results from this more
stringent measure are similar to those presented in the paper; shareholders are more likely to vote
against auditor ratification when auditor tenure is long.

DISCUSSION
Shareholders dissatisfied about auditor quality or the credibility of management’s reports have
a variety of actions at their disposal, including selling their shares as opposed to voting against
auditor ratification 共Raghunandan 2003兲. But selling shares imposes significant costs to sharehold-
ers, while voting against auditor ratification is a relatively low-cost option for shareholders to send
a signal to management. In the context of issues such as nonaudit service purchases, investors may
believe that there is no difference among, for example, the Big 4 firms; so voting against one audit
firm will not change management’s behavior. But this argument is not valid in the context of
auditor tenure, because by expressing displeasure against one long-tenure Big 4 auditor the inves-
tors could force management to select another auditor of the same type but without the taint
associated with long tenure.
Our results indicate that a statistically significant association exists between long auditor
tenure and the proportion of shareholders not voting for auditor ratification. Yet, we find that only
a small proportion of shareholders vote against auditor ratification, and one can argue that only a
very small proportion of shareholders appear to be concerned about long auditor tenure. This then
raises the question: Does it really matter if the proportion of shareholders voting against the
auditor is 2 percent or 4 percent?
We argue that the low proportion of votes against 共or abstaining from兲 auditor ratification
must be placed in the overall context of shareholder voting. The reality is that many shareholders
are extremely passive, and it is often quite an accomplishment to obtain significant votes against
a so-called “routine management proposal.” For example, Cai et al. 共2007兲 examine 12,726 direc-
tor elections at 2,488 different shareholder meetings between 2003 and 2005, and find that the
median “For” votes in director elections is 97 percent; they note that votes exceeding 90 percent
are the norm even for poorly performing firms and directors. Furthermore, Mishra et al. 共2005兲
show that shareholder votes against auditor ratification were 1.6, 3.4, and 4.9 percent in 2001,

10
The only noticeable difference is that the coefficient of Log共Tenure兲 changes from 0.395 to 0.433.

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Auditor Tenure and Shareholder Ratification of the Auditor 309

2002, and 2003, respectively. Thus, even during the auditing profession’s darkest hours in
many decades, more than 95 percent of shareholders routinely ratified the auditor selected by
management.
Second, the statistical significance of our results can be viewed in another way. We use the
same regression model noted in Table 3 共model 1兲, but without the tenure variable. The adjusted
R-square in such a model drops to 24 percent; thus, the addition of auditor tenure leads to a
one-third increase in the explanatory power of the model 共from 24 percent to 32 percent兲.
Finally, debates over auditor tenure matter greatly to regulators and the audit firms; so any
study that can provide insights about this issue are quite relevant. From the actions of the Big 4,
it is clear that the firms were quite afraid of mandatory auditor rotation and expended significant
effort to stave off congressional action on this issue. In our view, this speaks to the importance of
understanding shareholders’ views of auditor tenure even if most shareholders are passive regard-
ing auditor ratification 共in addition to being passive about director appointments and shareholder
resolutions兲.

SUMMARY AND CONCLUSIONS

Legislators, regulators, and the media have expressed concerns about the effects of long
auditor tenure on audit quality. In this paper we examine shareholders’ perceptions about auditor
tenure to fill a void in the literature, and to provide an empirical grounding about investors’ views
for future debates related to the effects of auditor tenure. We use shareholder votes on auditor
ratification as a proxy for investor perceptions about audit quality.
Using voting data from 635 firms during 2006, we find that shareholders are more likely to
vote against or abstain from ratification of the auditor when the auditor tenure is long. This
suggests that shareholders view long auditor tenure as adversely affecting audit quality. The above
findings provide an empirical basis for arguments related to the impact of long auditor tenures on
shareholders’ perceptions. The results can also be viewed as supporting proposals for mandatory
auditor rotation.
Many recent empirical studies have shown that measures of audit quality do not deteriorate
with the length of the auditor-client relationship. In fact, some studies suggest that financial
reporting or audit quality may be lower in the initial years of an audit engagement. Our results for
short-tenured clients indicate that shareholders are more likely to vote for auditor ratification when
the auditor tenure is short. Thus, shareholder voting—at least with respect to short-tenure
clients—is not consistent with the findings from other research about auditor tenure. What can
explain this divergence?
One possible explanation is that investor perceptions can be at variance with results from
empirical research; for example, while many archival-empirical studies show that there is no
negative association between nonaudit services and financial reporting quality 共DeFond and Fran-
cis 2005兲, surveys suggest that investors perceive nonaudit services as affecting auditor indepen-
dence 共SEC 2000a兲. Another possibility is that investor perceptions are affected by discussions in
the media 共and by policy-makers兲 about the adverse effects associated with long auditor tenures
and the benefits from mandatory auditor rotation. This in turn raises another question. Why do the
media continue to highlight some failures associated with long auditor tenures, while not giving as
much attention to audit failures with shorter tenured clients? Bias is one possible answer. Another
possibility is that it takes time before results from research seep through the popular media 共and
then to investors’ perceptions and actions兲. This suggests that an interesting avenue for future
research is to examine the divergence between results from empirical research and media discus-
sion about issues of policy interest to legislators and regulators.

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310 Dao, Mishra, and Raghunandan

APPENDIX
PRIOR RESEARCH ON AUDITOR TENURE

Study Dependent Variable Sample Findings

Loebbecke et al. 共1989兲 Likelihood of Survey of 121 audit Nearly a quarter of the
irregularities partners, with irregularities occurred on
knowledge of 354 new audit clients.
actual irregularities
Stice 共1991兲 Likelihood of lawsuit 49 firms during Lawsuits more likely
against auditor 1960–1985 when auditor tenure is
three years or less.
Knapp 共1991兲 Probability that auditor Survey of 122 audit Audit committee
would discover a committee members members perceive that
material error and audit quality initially
require error correction improves with auditor
or report the error. tenure but then starts to
decline over time.
Deis and Giroux 共1992兲 Quality metric based on 308 QC Reviews during Audit quality declines
the Quality Control 1984–1989 with the length of
共QC兲 Review letter of auditor tenure.
findings
Geiger and Raghunandan Going concern opinions 117 bankruptcies from Prior GC opinion less
共2002兲 for bankrupt firms 1996–1998 likely when auditor
tenure is low 共i.e., audit
reporting failures were
more likely in the initial
years of an audit
engagement兲.
Johnson et al. 共2002兲 Absolute value of 11,148 firm-year Relative to medium
unexpected accruals observations for the audit-firm tenures 共four
period 1986–1995 to eight years兲, short
tenures 共two to three
years兲 are associated
with lower quality
financial reports; no
evidence of reduced
financial reporting
quality for longer
tenures of nine or more
years.
Myers, Myers, and Omer Discretionary accruals 42,302 firm-years Longer auditor tenure is
共2003兲 or current accruals during 1988–2000 generally associated with
less dispersion in the
distributions of
discretionary accruals
and current accruals.
Myers, Myers, Palmrose, Financial statement 562 restatements The association between
and Scholz 共2003兲 restatements between January 1997 auditor tenure and
and October 2001 restatements is
context-specific, can be
either positive or
negative.

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Auditor Tenure and Shareholder Ratification of the Auditor 311

Study Dependent Variable Sample Findings

Carcello and Nagy Fraudulent financial 267 firms subject to Fraudulent financial
共2004兲 reporting AAERs between 1990 reporting is more likely
and 2001 to occur in the first three
years of the
auditor-client
relationship.
Iyer and Rama 共2004兲 Probability of having Survey of 124 CPAs Respondents from
the auditor not require a employed as CEOs, companies with short
liability to be recorded CFOs, controllers, and auditor tenures were
treasurers more likely to indicate
that they could persuade
the auditor to accept
their client positions in
case of a disagreement.
Mansi et al. 共2004兲 S & P credit rating and 8,529 firm-year Audit quality and tenure
yield spread observations, from 1974 are negatively and
to 1998 significantly related to
the cost of debt
financing.
Choi and Doogar 共2005兲 Going concern 共GC兲 30,344 firm-year For non-Big 5 auditors,
audit opinions observations for the longer auditor tenure is
period 1996 to 2001 negatively associated
with the likelihood of a
GC opinion; for Big 5
auditors, no evidence of
association between
tenure and the likelihood
of a GC opinion.
Ghosh and Moon 共2005兲 Three different Sample sizes ranging Positive association
measures of earnings from 35,826 to 38,794 between auditor tenure
quality firm-years, during and 共1兲 investor
1990–2000 perceptions of earnings
quality, 共2兲 influence of
reported earnings on
stock rankings and 共3兲
influence of past
earnings on
one-year-ahead stock
prices.
Azizkhani et al. 共2007兲 Cost of equity capital 2,033 observations for Audit firm tenure and
the period 1995–2005 audit partner tenure are
significantly associated
with lower ex ante cost
of equity capital, but
only for non-Big 4 audit
firms.
Davis et al. 共2007兲 Meeting or beating 33,301 firm-years In both the early and
earnings forecasts during 1988–2006 later years of the
auditor-client
relationship, there is an
increase in the use of
discretionary accruals to
meet or beat earnings
forecasts.

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312 Dao, Mishra, and Raghunandan

Study Dependent Variable Sample Findings

Gul et al. 共2007兲 ROA adjusted accruals 1,846 firms from 2000 There is a positive
and 2,874 firms from association between
2001 nonaudit fees and
positive discretionary
accruals for relatively
small firms with shorter
auditor tenure.
Knechel and Vanstraelen Going concern audit 618 private Belgian In the nonbankrupt
共2007兲 opinions firms during 1992–1996 sample, some evidence
of a negative association
between auditor tenure
and the issuance of a
going concern opinion.
Stanley and DeZoort Financial statement 382 firms during Restatements are more
共2007兲 restatements 2000–2004 likely to occur in the
initial years of an audit
engagement.

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