On the Political Decision of Audit Market Regulation: Empirical Evidence of Audit Firm Tenure and Maximum Durations within the European Union

Markus Widmann,Matthias Wolz,Florian Follert

doi:10.3390/economies9020079

Abstract

After almost every economic crisis and corporate scandal, political actors announce the need for stricter regulatory measures for financial markets and companies, in an attempt to appease their voters and defend their political agenda. Regarding the latest international financial crisis, the EU responded, among other things, with comprehensive regulation of the European audit market. In the context of auditor rotation, after 17 June 2016, the duration of audit engagements should not exceed a maximum of 10 years. In this paper, we therefore investigate whether there is empirical evidence behind the 10-year threshold—or is it simply arbitrary? Our aim is to evaluate the audit market reform by the European Union (EU) (Regulation (EU) No 537/2014 and Directive, 2014/56/EU) related to the objective of improving the quality of audits. Therefore, our article addresses the most crucial element of this reform, the implementation of a mandatory audit firm rotation for public interest entities (Regulation (EU) No 537/2014, Article 17). Based on a unique dataset of 11,834 firm observations from all listed companies within the EU between 2008 and 2017, we provide for the first time a discussion basis for the assessment of audit market interventions by the EU. Hence, we compare the new maximum durations with average audit tenure in the particular member states. Even where we present only descriptive results, our results at least indicate that the “magic number” 10 (years) could be more the result of a political process—i.e., a consent between the European institutions—rather than evidence based. Therefore, our findings shall serve as a first starting point in the discussion of a vast and interdisciplinary research field.

Highlights

The Regulation of the (European) audit market has a long tradition (e.g., Evans and Honold 2007; Humphrey et al 2011; Naumann 2014), even before the Fourth Directive in 1978 (78/660/EEC) was implemented
10.14 tional structure of the European Union (EU), we identify three institutions that determine political decisions themaximum agreed maximum duration of years before mandatory audit firm rotaareduce possible based on the Choice framework for collective decision-makfinal regulation the respective
Collective is Taking the agreed maximum duration of years before mandatory audit firm rotational structure of the EU, we identify three institutions that determine political decisions ing by Buchanan and

Summary

Introduction

The Regulation of the (European) audit market has a long tradition (e.g., Evans and Honold 2007; Humphrey et al 2011; Naumann 2014), even before the Fourth Directive in 1978 (78/660/EEC) was implemented. A generally accepted approach to explain the need for an external audit is the agency relationship between the management (agent) of a corporation and its shareholders (principals) (e.g., Ross 1973; Jensen and Meckling 1976), which is based on the separation of ownership and control (Berle and Means 1968). New problems of asymmetrical distribution of information arise through the auditor as an agent before the mandate is issued (problem of adverse selection through hidden characteristics) or after the mandate is issued (moral hazard through hidden action and hold-up through hidden intention) (concerning auditing see, e.g., Ewert 1990; Marten 1994). The auditor’s performance depends largely on his or her individual level of effort, if we assume that only capable auditors act in the market

Objectives

Discussion

Conclusion