Audit Partner Tenure and Cost of Equity Capital

Abstract

SUMMARY We examine whether audit engagement partner tenure and rotation affect investors' perceptions, as proxied by the ex ante cost of equity capital. We find that partner tenure has a nonlinear relation with the ex ante cost of equity capital for non-Big 4 audit engagements prior to the introduction of partner rotation requirements, and that the imputed gains from partner tenure appear similar to the imputed gains of having a Big 4 auditor. Consistent with the tenure results, we also find that partner rotation is associated with increased ex ante cost of equity capital. Our results are very robust to a variety of sensitivity tests and raise important questions for future research. It is not known to what extent investors or analysts are aware of the audit partner's identity or pay attention to audit partner tenure; if investors or analysts do not consider partner tenure, future research may identify omitted variables that have the same nonlinear relationship with the ex ante cost of capital that we observe for non-Big 4 audit partner tenure. JEL Classifications: M42; M48. Data Availability: The data used are from public sources identified in the manuscript.