Audit firm tenure, auditor familiarity, and trust: Effect on auditee whistleblowing reporting intentions

• DOI: http://doi.org/10.1111/ijau.12108
• Author: Claire Kamm Latham,Aaron B. Wilson,Casey McNellis
• Published date: 01 July 2018
• Date: 01 July 2018

ORIGINAL ARTICLE

Audit firm tenure, auditor familiarity, and trust: Effect on

auditee whistleblowing reporting intentions

Aaron B. Wilson

1

|Casey McNellis

2

|Claire Kamm Latham

3

1

School of Accountancy, Ohio University,

Athens, OH, USA

2

School of Business Administration, Gonzaga

University, Spokane, WA, USA

3

Department of Accounting, Washington

State University, Vancouver, WA, USA

Correspondence

Aaron B. Wilson, School of Accountancy,

Copeland 636, Ohio University, Athens, OH,

USA.

Email: wilsona5@ohio.edu

Mandatory audit firm rotation has been researched for decades with resulting opposition as well

as support. Research has mainly treated mandatory auditor rotation at the firm macro level. We

submit the client relationship length is comprised of firm tenure and audit team continuity, or

auditor familiarity. Increased tenure, at the interorganizational or firm level and interpersonal or

individual level, has been shown to increase trust; and further, trust is positively related to

employee voice, such as speaking up about fraud (whistleblowing). We conduct an experiment

examining whether increased audit firm tenure and auditor familiarity leads to increased trust,

which enhances the willingness to whistleblow. We find evidence that suggests auditor familiarity

enhances trust, which, in turn, positively influences an employee's intentions to whistleblow. This

has important implications for the profession and for future research exploring mandatory audit

firm rotation; in particular, the need to include auditor familiarity as a construct.

KEYWORDS

auditor reputation, ethics, external audit, fraud, public accounting firms

1|INTRODUCTION

Mandatory audit firm rotation has been discussed and researched for

decades with arguments for it having a positive effect on audit out-

puts as well as support for it being problematic. A series of studies

(Arrunada & Paz‐Ares, 1997; Geiger & Raghunandan, 2002; Ghosh

& Moon, 2005; Johnson, Khurana, & Reynolds, 2002; Mansi,

Maxwell, & Miller, 2004; Myers, Myers, & Omer, 2003; Palmrose,

1987, 1991; Petty & Cuganesan, 1996; Stice, 1991) indicate gener-

ally that audit firm rotation would not necessarily be beneficial due

to the loss of specific client knowledge. This loss of knowledge would

theoretically result in increased audit risk during the first years of a

new audit firm engagement. On the other hand, more recent research

(Brooks, Cheng, & Reichelt, 2012; Chi & Huang, 2005; Davis, Soo, &

Trompeter, 2009) argues that mandatory audit firm rotation would be

of benefit, decreasing the risk of auditor independence concerns. In

the USA, the Public Company Accounting Oversight Board (PCAOB)

issued a concept release seeking comments regarding the imple-

mentation of mandatory audit firm rotation (PCAOB, 2011); however,

in September 2014, they concluded their 3‐year investigation into

the merits and disadvantages of mandatory audit firm rotation with-

out implementing additional changes. In contrast, the European

Parliament, in April 2014, approved new rules regarding mandatory

audit firm rotation in the European Union (Katz, 2014; Köhler, Quick,

& Willekens, 2016). The new rules allow for each of the 28 member

nations to determine individual tenure limits with the overriding limit

of a maximum of 10 years.

Research has predominantly treated mandatory auditor rotation at

the firm macro level. The recently released AICPA Code of Professional

Conduct (AICPA, 2015) brings in the construct of familiarity threat,

considering it from both an individual and firm level. The new code

defines familiarity threat as “(t)he threat that, due to a long or close

relationship with a person or an employing organization,amember will

become too sympathetic to their interests or too accepting of the

person's work or employing organization'sproduct or service.”(AICPA,

2015, p. 134) and notes that, in and of itself, it is not a negative but

a risk that should be assessed with appropriate quality control in place

(AICPA, 2015, p. 24). As it relates to the length of relationship with the

client, the construct of familiarity is comprised of two components:

firm tenure and audit team continuity. Hence, we argue that it is

important to consider this aspect of familiarity, audit team continuity,

within the discussion of audit firm rotation.

Increased tenure, at both the interpersonal and interorganizational

level, has been shown to increase trust in a relationship. For example,

Rennie, Kopp, and Lemon (2010) find that trust is enhanced with

increased auditor–client tenure. Whereas excessive trust may weaken

Received: 3 December 2016 Revised: 13 September 2017 Accepted: 26 October 2017

DOI: 10.1111/ijau.12108

Int J Audit. 2018;22:113–130. © 2018 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/ijau 113

professional skepticism (Rose, 2007; Shaub, 1996), Richard (2006) and

Rennie et al. (2010) posit that trust is a necessary and critical compo-

nent of an audit. Relationship trust enhances confidence in each

other's reliability, and honesty (Cote & Latham, 2006). Increased trust

minimizes uncertainty associated with opportunistic behavior and

increases the likelihood of partners taking greater risks (Birnberg,

2004; Cote & Latham, 2006; Morgan & Hunt, 1994). Gao, Janssen,

and Shi (2011) found that trust is positively related to employee

voice—that is, speaking up about workplace issues—and that trust

allows the employee to be vulnerable and take risks. Seifert,

Stammerjohan, and Martin (2014) show that interpersonal and interor-

ganizational trust mediates the relationship between organizational

justice and the likelihood of whistleblowing.

Speaking up about fraud (whistleblowing) is a risk‐taking activity.

However, the Association of Certified Fraud Examiners’(ACFE) 2016

Report to the Nations on Occupational Fraud and Abuse (ACFE,

2016) highlighted the significance of reporting intentions, indicating

that 43.5% of occupational fraud in companies with more than 100

employees was initially discovered through tips and is by far the largest

source of fraud detection.

1

Thus, research into what enhances

whistleblowing is important. We explore whether increased audit firm

tenure and auditor familiarity lead to increased trust which will posi-

tively impact one's willingness to whistleblow.

This research extends the literature in mandatory audit firm rota-

tion, trust, and whistleblowing with the specific consideration of conti-

nuity of audit teams. Accordingly, the current study appropriately

disentangles the constructs of tenure and familiarity to understand

their impact on client employees’reactions in the event of discovered

wrongdoing. The respondents in this study include 235 subjects, serv-

ing as proxies for entry‐level client employees. In a between‐subjects

design, subjects completed a hypothetical case with audit firm tenure

varied across four conditions and familiarity with the individual auditor,

as the construct for audit team continuity, manipulated across two

conditions. Our results suggest that continuity of the makeup of audit

teams matters. We find that auditor familiarity enhances trust in the

auditor, which, in turn, positively influences an employee's intentions

to whistleblow. On the other hand, audit firm tenure, in the absence

of familiarity, did not produce significant benefits to trust in the indi-

vidual auditor

This study, from the research design to the results, offers key con-

tributions to both the literature and practice. The separation of the

familiarity and tenure constructs provides a different perspective in

the literature, as it holds significant implications for future research

exploring mandatory audit firm rotation and other issues surrounding

the auditor–client relationship. The results of this study substantiate

familiarity with the auditor, and thus the past working experiences

between client and firm personnel, as the foundation for trust in the

professional relationship. While accounting firms offer an umbrella of

reputational benefits for their individual auditors (Knechel, Krishnan,

Pevzner, Shefchik, & Velury, 2013), our findings highlight for the pro-

fession the importance of client familiarity with individual auditors as

a key ingredient of trust and, by extension, the enhancement of audit

quality in the form of increased cooperation in the auditor–client rela-

tionship. As such, this study holds implications for the profession

regarding the importance of audit team continuity.

The remainder of our paper is structured as follows: we provide a

discussion of the current research related to audit firm rotation and the

development of our hypotheses based on trust, auditor familiarity, and

whistleblowing literature; we then address methodology and data

gathering; finally, we provide our results and conclusions and discuss

study limitations.

2|BACKGROUND AND HYPOTHESES

DEVELOPMENT

2.1 |Mandatory audit firm rotation

The discussion regarding the need to implement mandatory audit firm

rotation has been simmering for decades, beginning with the Metcalf

Report (United States Senate, 1976) identifying the imaginable neces-

sity of mandatory audit firm rotation in 1976. In 1978, the concept of

mandatory firm rotation was deferred and the practice of audit partner

rotation was introduced as a result of the Cohen Commission (AICPA,

1978). A decade and a half later, the conclusions of the Ryan commis-

sion (AICPA, 1992) suggested that mandatory audit firm rotation has

its disadvantages, with the primary concern being that increased audit

tenure reduces audit risk due to deep and thorough knowledge of the

client's business and related risks.

The Securities and Exchange Commission (SEC) returned to the

debate again in 1994 but determined that the practice of using a

review partner was sufficient (SEC, 1994). In 2003, the Government

Accounting Office (GAO) endorsed postponing discussion of manda-

tory audit firm rotation citing that time was necessary to be able to

quantify the success of the 2002 Sarbanes‐Oxley Act (GAO, 2003).

The debate has again been rekindled as a result of the PCAOB

resurrecting the issue by issuing a concept release requesting com-

ment regarding the implementation of mandatory audit firm rotation

(PCAOB, 2011). In 2014, the PCAOB gave up on its pursuit of manda-

tory audit firm rotation (Katz, 2014).

Following the global recession in 2008, the European Union began

its own inquiry into the benefits of mandatory audit firm rotation. A

2011 proposal initially suggested a 6‐year audit firm rotation and the

breakup of accounting firms’audit and consulting services (Chasan,

2014). The goal, as communicated by Michel Barnier, the European

Internal Market and Services Commissioner, was to “reduce risks of

excessive familiarity between statutory auditors and their clients,

encourage fresh thinking, and limit conflicts of interest”(Chasan,

2014). In April 2014, the European Parliament enacted guidelines

requiring mandatory audit firm rotation for its 28 member nations

(Katz, 2014). Each nation has the authority to establish rotation terms

independently, as long as they comply with the maximums established

by the European Parliament. The maximum established is 10 years

unless certain exceptions are met (Deloitte Academy, 2014). At the

end of the initial 10 years, a company can put the audit up for bid

and renew the existing audit firm, allowing for 20 years total (Köhler

et al., 2016; KPMG, 2014; Tysiac, 2014). The other exception is if

the company engages two audit firms to perform the audit, allowing

for up to 24 years before rotation is mandatory (Köhler et al., 2016;

KPMG, 2014; Tysiac, 2014). Mandatory audit firm rotation in the

European Union became effective in January 2016.

114 WILSON ET AL.