Long-term audit engagements and opinion shopping: Spanish evidence

Abstract

Auditor tenure is an issue that has attracted considerable attention recently. This interest has focused mainly on determining whether long-term audit contracts improve the quality of the service. So far, research has failed to provide a definite answer to this question. In the face of this lack of consensus, we wish to analyze the relationship between the length of the audit contract and auditor independence. Specifically, using a model that includes control variables as proxies for the auditor’s economic incentives, we analyze whether long-term audit contracts increase the possibility of a company’s engaging in opinion shopping. We develop an opinion shopping model, together with univariate and logistic regression models. Our results show that the longer the audit engagement, the lower the probability of opinion shopping. The implications for mandatory auditor rotation regulation are also discussed.

Keywords:

• Auditor tenure
• Opinion shopping
• Independence
• Mandatory auditor rotation
• Big 5
• Spanish context

Acknowledgements

We acknowledge helpful suggestions from two anonymous reviewers, the Editor (Professor Lehman), Prem Sikka, Christopher Humphrey and Nieves Carrera on earlier drafts of this manuscript. We gratefully acknowledge the financial support provided by the Spanish Ministry of Science and Technology (BEC2002-03043).

Notes

1 In the majority of regulatory systems, the engagement of auditors is a function of the shareholders. However, the dispersion of share ownership, above all in very large companies, and the lack of shareholder participation in company general meetings, lead to the directors’ controlling the auditor appointment decision, including the selection, renewal and dismissal of the auditors.

2 Different studies use brand names to capture reputation effects. Empirical research suggests that the international audit firms have reputations for higher audit quality, because these firms have more reputation capital to protect. The Big 5 have more incentive to avoid reputation-damaging criticism and to maintain their investment in reputation capital (Francis & Wilson, 1988; Simunic & Stein, 1987). Normally this variable is measured by the dichotomy between Big 5 and non-Big 5 auditors, the differences between international firms not being captured.

3 Approximately 50% of litigation against auditors involves client bankruptcy or severe financial distress St. Pierre & Anderson, 1984). Given this environment, auditors may attempt to reduce their litigation exposure by acting more conservatively when issuing opinions to distressed clients (Francis & Krishnan, 1999; Krishnan & Krishnan, 1996, 1997).

4 In this context, it should be noted that several studies have analyzed a sequence of observable events such as the opinions issued before and after an auditor change. When a company obtains a more favorable audit opinion after the change of auditor, without its financial situation having altered, one could speak of the existence of opinion shopping. The empirical evidence available in this type of study reveals that, although companies show a greater propensity to change their auditors when they receive qualified reports, they do not, on the contrary, generally obtain an improvement of opinion after undertaking an auditor change (Gómez Aguilar & Ruiz Barbadillo, 2003; Krishnan & Stephens 1995; Lennox, 2000).

5 For example, in the case of Arthur Andersen, we expect that most of the clean audit opinions will be in the range (0, 0.33) and most of the qualified opinions in the range (0.33, 1). Then, if we focus on the companies that receive a clean report, when the company’s estimated probability takes a value between (0.33, 1), we can consider that opinion shopping exists.