Does the Length of the Cooling-Off Period Impact Audit Quality?

Abstract

Several countries have implemented a policy of mandatory partner rotation (MPR) in response to concerns around auditor independence. Integrated within MPR requirements, minimum cooling-off periods regulate audit quality at the time of a rotation-back. Within the context of a proposed extension to the minimum cooling-off period, we examine the association between the length of the cooling-off period and audit quality. We use Australian data as the partner can be identified and there is variation in cooling-off periods since the inception of MPR. We consider the merits of an extended cooling-off period by measuring audit quality both at the time of a rotation-back and at the expiration of a cooling-off period. Consistent with prior literature, we measure audit quality as abnormal working capital accruals and the auditor’s propensity to issue a going-concern opinion for financially distressed firms. For rotation-back observations, we find no evidence of an association between the length of the cooling-off period and audit quality. For cooling-off period observations, we find some evidence of larger abnormal working capital accruals and a lower propensity to issue a going-concern opinion, consistent with a deterioration in audit quality associated with longer cooling-off periods. We provide preliminary evidence that extending the cooling-off period does not enhance audit quality when a partner rotates-back on to a client and uncover an unintended consequence of the effect of this policy during the cooling-off period.