Abstract

The European legislator has introduced a mandatory audit firm rotation principally after ten years and with regard to a cooling off period of four years to increase auditor independence. This kind of external rotation complements the existing internal mandatory rotation (auditor rotation). This paper implies a critical review of the economics need of rotation rules. In contrast to the perception of the European standard setter, mandatory external rotation will not automatically lead to an increased financial accounting and audit quality.

Highlights

  • In the wake of the financial crisis, regulators and shareholder activists alike have been revisiting the issue of auditor independence with a view towards requiring companies to periodically rotate their outside audit firms

  • In order to increase auditor independence, based on independence as well as in appearance, an external rotation principally after ten years and with regard to a cooling off period of four years is mandatory for public interest entities

  • In light of the recent explosiveness caused by the European audit reform as well as various forms of rotation from an international point of view, the assumption of a positive link between external rotation and quality of financial accounting and auditing is to be subject to further scrutiny

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Summary

Introduction

In the wake of the financial crisis, regulators and shareholder activists alike have been revisiting the issue of auditor independence with a view towards requiring companies to periodically rotate their outside audit firms. Facing the capital markets’ shrinking trust in the decision usefulness of financial accounting and auditing as a result of the financial crisis, the European legislator has finalized the audit reform this year. The aim of the regulation is to increase audit quality by reducing the expectation gap, to increase auditor independence and to prevent further audit market concentration. In light of the recent explosiveness caused by the European audit reform as well as various forms of rotation from an international point of view, the assumption of a positive link between external rotation and quality of financial accounting and auditing is to be subject to further scrutiny

Theoretical Foundation
Empirical Rotation Research
Conclusion
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