Abstract
Abstract This study aims to assess the effect of the rotation and tenure of audit firm and audit partner on the comparability and consistency of financial reports. Several studies have addressed the effect of auditor rotation on the quality of financial reports, but none of them focused specifically on the impact on the comparability and consistency of financial reports. Around the world, the impact of mandatory rotation of audit partner and audit firm is being discussed in academia and regulatory bodies. The peculiarity of the Brazilian regulatory environment allows us to contribute to the discussions on the effects of implementing mandatory auditor rotation. Our sample included 50 companies for which we analyzed data from 2012 to 2018. To measure comparability, we used the similarity of the accounting function model by DeFranco, Kothari and Verdi (2011), and to measure consistency we used the adaptations to this model proposed by Ribeiro (2014). For data analysis, we used descriptive statistics and multivariate panel analysis. Our results suggest that the rotation (mandatory and voluntary) of audit firm and audit partner does not affect the comparability and consistency of financial reports. Results also suggest that auditor-client relationships of up to three years contribute to a significant increase in comparability and consistency, indicating that mandatory rotation does not impair investors’ ability to compare the information concerning their investments. In addition, regulators are shown that a possible reduction in the mandatory rotation term (from five to three years, as in Italy) would be in line with market practices and would imply an increase in the comparability and consistency of financial information.
Highlights
Since its inception, the external auditor’s role is to bring credibility to the information companies provide about their economic and financial performance
Our results show that mandatory audit firm rotation, voluntary audit firm rotation or audit partner rotation do not affect the comparability and consistency of financial statements
This study aims to contribute to the discussion on the need for audit firms and partners to rotate the auditor within up to five years, as established by law, in the same way that it aims to contribute to the discussion on the rotation being carried out in less than five years, as audit firm and partner rotation do not impair comparability and consistency of financial statements
Summary
The external auditor’s role is to bring credibility to the information companies provide about their economic and financial performance. Research by DeFond and Zhang (2014) and Casterella and Johnston (2013) indicate a positive association of between auditor tenure and higher earnings quality, as measured by accrual earnings management and other criteria like accounting conservatism Many of these studies attributes this result to expertise gains from the audit work, in a relationship in which the auditor or the firm tenure is longer. Our findings indicate that audit firm tenure of up to three years positively influences both the comparability and the consistency of financial statements These findings are in agreement with the evidence presented by DeFond and Subramanyam (1998), which identified a preference for more conservative accounting choices by the auditor in the case of auditor rotation due to the greater litigation risk, and with Chi et al (2011), whose results suggest a trade-off between real activities manipulation and accrual manipulation by managers in long-term auditor-client relationships. We understand that the positive effects of auditor rotation such as enhanced independence from the client outweigh other positive effects, such as expertise gains from longer tenure in terms of comparability and consistency of financial statements in the analyzed environment
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