Does Mandatory Auditor Rotation Increase Audit Quality? A Test of Indonesian Ministry of Finance’s Decree Effectiveness

Abstract

A bstract : We investigate whether auditor’s mandatory rotation affects audit quality. In specific, we test the effectiveness of Ministry of Finance’s (MOF) decree no. 423/2002. Following some other researches that investigate audit quality, we use discretio nary accruals as the proxy of audit quality. Our test result suggest s that audit quality is lower after the rotation than before the switching. T his result is surprisingly unexpected since we expect post - rotation auditor will be more skeptical and conserva tive to its new client and therefore will push the discretionary accrual down. We conjecture that auditors have anticipated that MOF decree for two reasons . Firstly, more than half of our sampled rotations (58%) take place on 2002 or 85% of sampled firms b y 2003 . It proves that companies and their auditors have anticipated this decree. Secondly, some local accounting firms dissolve their partnerships and re establish a new one while both of them retaining their foreign associates. If the pre and post - manda tory auditors are in fact the same accounting firm since they have the same foreign affiliation , there is no surprise that we will not observe some change in the audit the quality. In this research, w e, however, consider this switch as a mandatory rotation since lawfully the company is audited by different auditor . Our samples are suffers from this limitation.