Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

Abstract

In this paper we provide evidence on specific factors that could affect audit quality under mandatory rotation, using data from Korea where mandatory auditor rotation was put into effect in 2006. We find no evidence supporting the “Brillo pad effect” (the argument that departing auditors have incentives to clean up the balance sheet) or the “new broom effect” (the argument that new auditors can find problems that long-standing auditors tend to overlook). On the contrary, departing auditors spend fewer hours just before rotation, consistent with a lack of incentives to maintain quality given the impending rotation. Compared to clients in other mandatory rotations, the clients rotating away from industry specialist auditors have higher audit hours and higher absolute discretionary accruals post-rotation, suggesting there are adverse effects from breaking such auditor-client pairings. Finally we find that Big 4 auditors’ market share continues to increase after mandatory rotation is imposed. Our findings therefore fail to support mandatory rotation.