The Impact of Auditor Selection Regime and Audit Committee Autonomy on Investment Decisions

Abstract

After the recent financial crisis, regulatory bodies proposed and, in some cases, enacted alternative auditor selection processes such as mandatory audit firm rotation or mandatory tendering. Although in many countries the audit committee has the authority to appoint the external auditor, in practice management frequently has substantial influence over such decisions. We posit that high appointment power of the audit committee will enhance the effectiveness of rotation and tendering, thus, increasing investment recommendations. In this experimental study involving 118 experienced investment professionals, we examine the impact of the auditor selection process (mandatory rotation, mandatory tendering, and voluntary selection) and the appointment power of the audit committee (high, low) on investment recommendations. The results indicate that, first, audit committee appointment power affects investment recommendations only when a possible auditor change is anticipated (i.e., in the case of rotation and tendering), but not when the auditor selection is voluntary. Second, rotation and tendering both lead to a higher recommended investment likelihood than voluntary selection, but only when an audit committee has high appointment power. In all, the results highlight that the auditor selection process and audit committee appointment power are viewed by investors as interdependent.