Audit tenure and the equity risk premium: evidence from Jordan

Abstract

PurposeThe purpose of this paper is to investigate the relation between audit firm tenure and the perceived audit quality measured by the client‐specific equity risk premium. The study population consists of all the manufacturing and service firms traded in Amman Bourse during the period 2002‐2005.Design/methodology/approachThe Boone et al. model – with some modifications – was used for testing the hypotheses.FindingsThe results show that the relation between audit firm tenure and equity risk premium is positive, the equity risk premium increases with tenure as a result of reduced audit quality. These results were consistent with some previous studies, which showed that long relationships between an audit firm and a client are associated with lower perceived audit quality and, as a result, higher equity risk premium.Practical implicationsThe audit firm should be rotated in order to enhance auditor independence and audit quality, and increase investors' confidence in reported earnings. Additionally, investors are encouraged to give higher attention to the tenure of the audit firm when evaluating the quality of the financial reports of the companies they are planning to invest in.Originality/valueThis is the first paper to provide evidence from a developing country about an important issue – audit quality – which is expected to support and sustain improvement of audit quality, and therefore, financial reporting quality.