The Spillover Effects of Mandatory Audit Partner Rotation: Evidence from Audit Adjustments

Abstract

We analyze whether and how mandatory audit partner rotation affects the audit adjustments for the rotated partner’s remaining clients. We argue mandatory audit partner rotation can affect audit production of remaining clients through two channels. First, it can cause audit partners to acquire unfamiliar new clients and thus shift their attention and effort away from existing ones. Second, it can destroy positive audit synergies by disrupting cross-audit information spillovers. Consistent with these conjectures, we find smaller income-decreasing audit adjustments for the rotated partner’s remaining clients after a mandatory rotation. The decrease in audit adjustments is more pronounced when new client acquisition driven by the rotation causes a large increase in the partner’s capacity demand and when the remaining client is in the same industry as the mandatorily dropped client. The evidence furthers understanding of audit production and underscores the interdependence among audits in an auditor’s client portfolio.