The Effect of Mandatory Audit Firm Rotation on Earnings Management and Audit Fees: Evidence from Iran

Mahdi Salehi,Hossein Tarighi,Javad Gholamzadeh,Grzegorz Zimon

doi:10.3390/jrfm15030102

Abstract

The present study aims to investigate the effects of mandatory requirements of audit firm rotation on earnings management among companies listed on the Tehran Stock Exchange (TSE). The study population consists of 1030 observations and 103 companies listed on the TSE during the years 2003–2012; moreover, the statistical technique used to test the hypotheses is panel data and pooled data. The results showed that the rule of mandatory audit firm rotation increased accruals-based earnings management (AEM) significantly. In addition, outcomes demonstrated that mandatory requirements of audit firm rotation did not have a significant influence on real earnings management (REM) and audit fees. Overall, our findings proved that the mandatory requirements of audit firm rotation in Iran have not been able to prevent the opportunistic actions of management at a time when they were faced with severe financial problems because of economic sanctions and auditors taking standardized systems-based auditing approaches. This research will make investors and others aware of the fact that mandatory audit firm rotation might be not effective in stopping managers wishing to manipulate the accounting figures. This paper actually suggests that when firms have financial distress, regulatory mechanisms such as audit firm rotation may not have a deterrent role. Our findings give lawgivers a stark warning that the length of an audit firm’s tenure should be based on the features of the audit market structure of each country.

Highlights

Owing to the important role that auditing has in financial statements, it has always enjoyed a high status in capital markets and accounting professions
One quarter of Iranian companies were audited by a big audit firm, and nearly 75% of the audit market is available to small audit firms, which is another sign of a drop in audit quality
The target of the third model is exploring the influence of mandatory requirements of audit firm rotation on audit fees charged by external auditors

Summary

Introduction

Owing to the important role that auditing has in financial statements, it has always enjoyed a high status in capital markets and accounting professions. The pressure of financial crises in many countries has increased the demand for high-quality auditing during recent years (Zureigat 2011; Kim 2021; Escaloni and Mareque 2021; Lukason and Camacho-Miñano 2021; Lukason and Camacho-Miñano 2019). The compulsory circulation of audit firms has always been one of the potential ways to improve the quality of the audit, and it has attracted more attention during recent years due to bolstering of the role of auditors in capital markets (Harris 2012)

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Conclusion