An analysis of the possible impact of mandatory audit firm rotation on the transformation and market concentration of the South African audit industry

Michael Harber,Ben Marx

doi:10.4102/jef.v12i1.227

Abstract

Orientation: Consistent with global concerns regarding the quality of audits and regulatory changes in Europe, South African audit regulations will require audit firms to rotate clients periodically, in an attempt to safeguard auditor independence and audit quality. In 2017 the South African audit regulator issued a ruling requiring mandatory audit firm rotation (MAFR) every 10 years, effective April 2023, primarily intended to improve audit quality. In addition to audit quality improvement, the regulator also believes that MAFR will stimulate transformation in the audit profession by building capacity of black-owned audit firms and allowing opportunities for small- and medium-tier audit firms to compete for the audits of listed companies. Research purpose: This study explores the perceptions of auditors and audit committee chairs of Johannesburg Stock Exchange-listed companies with regard to the direct and indirect financial effects of the implementation of MAFR in South Africa with respect to black economic empowerment and market concentration. Motivation for the study: No studies have explored this controversial additional objective of MAFR in South Africa. Research approach, design and method: An exploratory mixed-methods design is employed, using questionnaires derived from a review of the academic research and professional debate concerning MAFR. Main findings: Contrary to the intentions of the regulator, MAFR may not result in improved transformation of the audit profession and could in fact reduce the capacity of audit firms to pursue transformation initiatives. In addition, MAFR may not decrease the current degree of audit domination of the Big 4 firms of the JSE, possibly even further concentrating the industry, as audit committees and shareholders may be reluctant to appoint mid-tier firms as auditors of the large listed companies. Practical/managerial implications: Industry stakeholders and the regulator should consider targeted interventions to mitigate the potential for impaired transformation and further concentration of the industry which may result from implementation of MAFR in 2023. Contribution/value-add: The findings and conclusions will contribute to addressing concerns regarding the rate of black participation in the industry, as well as mitigating the potential unintended consequences of MAFR.

Highlights

Mandatory audit firm rotation (MAFR) has received a great deal of attention from national audit regulators and researchers in recent years
The purpose of this study is to examine the perceptions of auditors and audit committee (AC) with respect to whether or not MAFR will increase the rate of transformation in the audit industry and reduce market concentration, as intended by the Independent Regulatory Board for Auditors (IRBA)
The study found that it is unlikely that MAFR will improve transformation in the audit industry

Summary

Introduction

Mandatory audit firm rotation (MAFR) has received a great deal of attention from national audit regulators and researchers in recent years. Proponents of MAFR argue that long-tenure relationships between audit firms and clients can lead to audit failures because of high levels of familiarity that impair auditors’ independence and professional scepticism. The US regulator has repeatedly considered MAFR over the past two decades but has consistently decided in favour of audit partner rotation because of the negative consequences inherent in MAFR (Fontaine et al 2016). These two large auditing jurisdictions illustrate the international divide on the issue. Whereas some countries have adopted MAFR in recent years, most have decided against it or implemented it and subsequently repealed it, usually in favour of audit partner rotation (Ewelt-Knauer, Gold & Pott 2013)

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