Audit firm rotation, audit fees and audit quality: The experience of Italian public companies

Abstract

This paper examines some of the costs and benefits associated with audit firm rotation using data from Italy, where mandatory audit firm rotation has been in place since 1975. Previous studies in this area did not find consistent evidence of an association between audit quality and voluntary or mandatory audit firm rotation. A recent paper, examining Italian public companies audited by a Big 4 audit firm, uses proprietary data and finds no statistically significant association between audit firm rotation and audit quality. In this study, we hand-collect publicly available data for a larger sample of Italian public companies audited by a Big 4 and non-Big 4 audit firm (1583 firm-year observations) over a longer time horizon (1998–2011). We find that audit quality, proxied by two different measures of earnings management, improves following audit firm rotation for companies audited by a non-Big 4 audit firm. Additionally, we examine whether higher audit fees are associated with audit firm rotation. Our results indicate that following audit firm rotation, the total amount of fees paid to the auditor was lower for companies audited by a Big 4 and unchanged for companies audited by a non-Big 4 audit firm. The results of this study should be of interest to European and U.S. legislators who are currently, or have recently, considered implementing mandatory audit firm rotation in order to improve financial reporting quality.