An examination of perceptions of auditor independence and financial reporting quality when former auditors are hired

Abstract

This study examines perceptions of auditor independence (AI) and financial reporting quality (FRQ) when former auditors are hired by public companies into accounting oversight positions under differing strengths of corporate governance. Although the Sarbanes–Oxley (SOX) mandate of a one-year cooling-off period for the hiring of former audit engagement team members into accounting oversight positions (e.g., chief financial officer) may enhance perceptions of AI, it potentially sacrifices FRQ by restricting the hiring of candidates most familiar with a particular company's industry, risks, and controls. The results of this experiment suggest when a company (i) has strong corporate governance and (ii) hires an audit engagement team member without a one-year cooling-off period, stakeholders perceive financial statement quality to be highest as compared to all other experimental conditions. Interestingly, we also find hiring a former auditor who has not cooled-off one-year results in roughly the same perception of AI as hiring an auditor observing the one-year cooling-off requirement. Collectively, results suggest stakeholders may not perceive a benefit from the cooling-off requirement as independence is not viewed as enhanced and FRQ is viewed as diminished. Requiring disclosure of auditor alumnus hires, in lieu of a mandated cooling-off period, coupled with external measures of companies’ strength of corporate governance may be sufficient to protect AI and FRQ.