Mandatory Audit Firm Rotation Research Articles

Will mandatory audit firm rotation reduce audit market concentration in South Africa?

Purpose: Deconcentrating the audit market was one of the stated objectives of the proposed mandatory audit firm rotation (MAFR) ruling in South Africa. With MAFR being a contentious topic, this study aimed to explore the possible effect of MAFR on audit market concentration in South Africa in anticipation of the implementation thereof in 2023.Design/methodology/approach: A sample of 415 South African listed companies was studied for the period 2010–2018. Data were mainly captured from annual reports. Descriptive statistics and significance testing were performed on calculated concentration ratios and identified audit firm rotations.Findings/results: South African audit market concentration mirrored empirical evidence from most developed countries – with Big 4 audit firms dominating the audit market, whilst a monopoly within the Big 4 audit firm grouping was also evident. Based on observed audit firm concentration and audit firm rotation behaviour, it was anticipated that MAFR might further increase audit market concentration. A concerning result was the sheer scale of audit firm rotations to be carried out in anticipation of MAFR in 2023.Practical implications: This study identified the impairment of audit quality and increased costs as possible unintended consequences of MAFR in South Africa.Originality/value: This study contributed to the limited body of knowledge on the possible effect of MAFR in South Africa. This study proposed alternatives to MAFR and recommended areas for future research to support evidence-based decisions on remedies to address audit quality and audit market concentration in South Africa.

On the Political Decision of Audit Market Regulation: Empirical Evidence of Audit Firm Tenure and Maximum Durations within the European Union

After almost every economic crisis and corporate scandal, political actors announce the need for stricter regulatory measures for financial markets and companies, in an attempt to appease their voters and defend their political agenda. Regarding the latest international financial crisis, the EU responded, among other things, with comprehensive regulation of the European audit market. In the context of auditor rotation, after 17 June 2016, the duration of audit engagements should not exceed a maximum of 10 years. In this paper, we therefore investigate whether there is empirical evidence behind the 10-year threshold—or is it simply arbitrary? Our aim is to evaluate the audit market reform by the European Union (EU) (Regulation (EU) No 537/2014 and Directive, 2014/56/EU) related to the objective of improving the quality of audits. Therefore, our article addresses the most crucial element of this reform, the implementation of a mandatory audit firm rotation for public interest entities (Regulation (EU) No 537/2014, Article 17). Based on a unique dataset of 11,834 firm observations from all listed companies within the EU between 2008 and 2017, we provide for the first time a discussion basis for the assessment of audit market interventions by the EU. Hence, we compare the new maximum durations with average audit tenure in the particular member states. Even where we present only descriptive results, our results at least indicate that the “magic number” 10 (years) could be more the result of a political process—i.e., a consent between the European institutions—rather than evidence based. Therefore, our findings shall serve as a first starting point in the discussion of a vast and interdisciplinary research field.

Audit quality implications of regulatory change in South Africa

PurposeThis paper explores how technical constructions of audit practice are influenced by mandatory audit firm rotation (MAFR) regulations. The paper responds to calls for additional research on how external regulation influences audit quality and supplements the predominately quantitative research dealing specifically with firm rotation and its relevance for audit quality.Design/methodology/approachData are collected from South Africa which is the latest jurisdiction to adopt MAFR (from 2017). Detailed interviews with 49 participants comprising 24 audit partners and 25 non-auditors are conducted to explore how MAFR can impact audit quality. For this purpose, audit quality is defined according to a schematic developed interpretively and based on professional auditing standards and the prior research on audit quality.FindingsThere is no guarantee that MAFR will bolster auditors' independence or contribute to a more thorough audit approach. On the contrary, the effort required by incoming audit firms to gain an understanding of new clients coupled with material tendering costs is expected to decrease the profitability of audit engagements with adverse implications for audit quality. A loss of client experience and staff retention challenges may contribute further to a decline in audit quality. There may be some improvements to audit practice when an incumbent firm's work is going to be scrutinised by a new auditor but audit methodologies, including the nature and extent of testing performed, are not expected to change significantly because of MAFR. In this way, the regulation may be a symbolic response to a perceived decline in audit quality and auditor independence rather than part of an effective strategy to encourage more rigorous audit practice for the benefit of the users of financial statements.Originality/valueThe current paper provides one of the first exploratory accountants of how MAFR is expected to impact audit practice and, in turn, audit quality. The research responds to the call for more field-work studies on the mechanics of the audit process by engaging directly with practitioners instead of relying on inferential testing of broad audit quality surrogates. The study also makes an important empirical contribution by providing primary evidence on how external regulation influences audit practice from a seldom studied African perspective.

The influence of client importance on the audit quality: A study to understand external auditor’s role as the guardians of strong and justice organizations (Goal 16 sustainable development goals)

This study aims to see the effect of client importance on audit quality by comparing before and after the issuance of Indonesian government regulation member 20 of 2015, which states that there is no longer mandatory audit firm rotation for public accountant firm (KAP). By abolishing rotation obligation, the bonding between the client and public accountant firm will be stronger, therefore, the client’s importance will further reduce the quality of the audit. However, this study’s result does not find any difference in the effect of client importance on audit quality in the period before and after the elimination of the public accountant firm rotation obligation. These results indicate that Indonesia’s accountant public firms are still maintaining their integrity, possibly due to law enforcement and sanctions. Thus, auditors maintained their role as the agent of financial statements’ trust by providing a high-quality audit to promote accountable and transparent organizations.

Mandatory audit firm rotation: A student perspective An assessment of the perceived impact on auditor independence

Mandatory Audit Firm Rotation (MAFR), set to be implemented in South African from 1 April 2023, is poised by its propellers the world over as an essential reform in the efforts to improve auditor independence. Available literature suggests that there is no consensus regarding the impact of the implementation of MAFR. The divergent views on MAFR were demonstrated in recent time, with the European Union (EU) choosing to adopt it, while regulators in the United States decided to reject it. This paper examines the perspective of university auditing students on MAFR by examining the perceived impact it could have on auditor independence. The study finds that the majority (from 413 participants) of students surveyed are of the view that MAFR would yield positive outcomes on independence. The majority, however, agree on the MAFR Independence Benefit but warn about the possible negative consequences. MAFR will strengthen the independence of auditors.

The impact of mandatory audit firm rotation on the ability of directors to discharge their statutory duties

The impact of mandatory audit firm rotation on the ability of directors to discharge their statutory duties

Reflecting on Corporate Governance in South Africa: Lessons Learned and the Way Forward

Background: South Africa is a corporate governance pioneer. The King Reports have offered guidance to listed companies in the country since 1994 and unlisted entities since 2016. In the drive for corporate change, attention is increasingly placed on the role of activist shareholders, in particular institutional investors, given the size of their investments. Purpose/objectives: This study aimed to gauge institutional investors’ views on the differences between the King III and IV Reports related to positive aspects and room for improvement. Design/methodology/approach: Semi-structured interviews were conducted with selected institutional investors. Themes were then derived by conducting an interpretive thematic analysis. Findings: Interviewees commended the format and scope of the latest King Report but suggested that outcomes-based training should be offered to directors to ease implementation. Executive remuneration, director independence and auditor independence were highlighted as areas that require attention. Some interviewees questioned whether the current non-binding vote on executive remuneration is sufficient. They suggested that executive remuneration should be tied to performance outcomes across the triple bottom line. Participants recommended that director independence should be considered on a case-by-case basis, instead of strictly applying King IV’s suggested tenure guideline. Furthermore, mandatory audit firm rotation could enhance auditor independence, and hence transparency. Stakeholders are encouraged to demand enhanced transparency on corporate matters to enable more informed decision-making.

Mandatory Audit Firm Rotation for Listed Companies: The Effects in the Netherlands

The Audit Regulation was adopted in 2014 to address many of the perceived failings in the market for statutory audits. It introduced mandatory audit firm rotation for public-interest entities, including listed companies, as of 17 June 2020/2023. Mandatory audit firm rotation was also considered by the Dutch legislator in 2012. Therefore, many Dutch listed companies had already switched audit firm in anticipation of the national requirement. In this article, we investigate the effects of mandatory audit firm rotation in the Netherlands by examining the financial reports of Dutch listed firms over the financial years 2012–2016 and by conducting a survey among stakeholders. We conclude that there is broad support for mandatory audit firm rotation in the Netherlands. Although mandatory audit firm rotation was seen as controversial at the time of adoption, it is now considered desirable by various stakeholders, including auditors themselves. However, mandatory audit firm rotation appears to have had some adverse effects. Most notably, our study shows a higher probability of errors in first year audits. The discount in audit fees provided by audit firms to lucrative larger public-interest entities for first year audits—the trophy client effect—may exacerbate the negative effect on audit quality. The Audit Regulation’s goals to improve the market for statutory audits have not been met so far.

Mandatory rotation of audit firms and auditors in Greece

This paper aims to examine the question of whether the mandatory rotation of audit firms and auditors, which is part of the new European Audit Reform, is a desirable measure in Greece. A comprehensive literature review of related studies from Europe and around the world was performed to study the issue. We conduct an empirical analysis focusing on auditors working in Greek audit firms and present the results of the responses from 115 members of the Institute of Certified Public Accountants of Greece. Empirical findings provide mixed results with regard to the implications of mandatory rotation. Most of the respondents agree that mandatory rotation will increase the overall costs of the audit process. However, they also conclude that it will increase both auditor independence and resistance to the management of audited firms. The findings of the study should be of interest to policymakers, regulators and audit firms in Greece and Europe. This is the first study that investigates the effects of mandatory rotation on audit quality in Greece since the establishment of the new regulatory audit framework. The study focuses on auditors’ views considering their decisive role in achieving audit quality. The conclusions of this study are generally in line with those indicated in the literature.

Mandatory audit firm rotation: a critical composition of practitioner views from an emerging economy

PurposeThis study aims to address an acknowledged gap in the literature for the analysis of experienced practitioner views on the effects and implications of mandatory audit firm rotation (MAFR).Design/methodology/approachUsing an exploratory and sequential design, data was collected from South African regulatory policy documents, organisational comment letters and semi-structured interviews of practitioners. These findings informed a field survey, administered to auditors, investors, chief financial officers (CFOs) and audit committee members of Johannesburg Stock Exchange (JSE) listed companies.FindingsPractitioners expressed considerable pushback against the potential efficacy of MAFR to improve audit quality due to various “switching costs”, notably the loss of client-specific knowledge and expertise upon rotation. In addition, the cost and disruption to both the client and audit firm are considered significant and unnecessary, compared to audit partner rotation. The audit industry may suffer reduced profitability and increased strain on partners, leading to a decline in the appeal of the profession as a career of choice. This is likely to have negative implications for audit industry diversity objectives. Furthermore, the industry may become more supplier-concentrated amongst the Big 4 firms.Practical implicationsThe findings have policy implications for regulators deciding whether to adopt the regulation, as well as guiding the design of policies and procedures to mitigate the negative effects of adoption.Originality/valueThe participants are experienced with diverse roles concerning the use, preparation and audit of financial statements of large exchange-listed multinational companies, as well as engagement in the auditor appointment process. The extant literature presents mixed results on the link between MAFR and audit quality, with most studies relying on archival and experimental designs. These have a limited ability to identify and critique the potential’s witching costs and unintended consequences of the regulation. Experienced participants responsible for decision-making within the audit, audit oversight and auditor appointment process, are best suited to provide perspective on these effects, contrasted against the audit regulator’s position.

Auditor independence and professional scepticism in South Africa: Is regulatory reform needed?

Background: Quality financial reporting, which requires high quality auditing outcomes, aids the smooth functioning of capital markets. Setting: The South African audit regulator argues that the key auditor attributes of independence and scepticism are dangerously compromised in South Africa, resulting in impaired audit quality. The regulator responded in June 2017 with the issuance of mandatory audit firm rotation (MAFR) regulations, effective April 2023. This ruling has caused considerable debate and opposing views in the audit industry. Aim: This study explores the state of auditor independence and the degree to which professional scepticism is being exercised by South African auditors of exchange-listed companies through an analysis of the perceptions of experienced key stakeholders. The findings contribute to the rationale behind the regulator’s argument for the necessity and efficacy of MAFR. Method: The study uses a survey methodology across four key stakeholder groups experienced in matters concerning the audit process, auditor appointment and reliance on the audit outcome on the Johannesburg Stock Exchange. Results: Respondents do not believe that auditor independence and professional scepticism are impaired, nor that existing regulations and codes of practice need amendment. In addition, audit failures and corporate financial scandals are not believed to be a result of compromised auditor independence and professional scepticism, nor do longer audit firm tenures impair independence and professional scepticism. Conclusion: These perceptions provide evidence against the rationale for MAFR adoption and indicate that it may not be necessary or effective. The study contributes to the South African audit profession in its objective to maintain audit quality. As such, it is relevant to regulators, standard-setters and stakeholders in South African capital markets.

IMPACT OF THE INTERPLAY BETWEEN FORMAL AND INFORMAL INSTITUTIONS IN THE CORPORATE GOVERNANCE AND INDEPENDENCE OF AUDIT FIRMS: A COMPARATIVE STUDY OF CEECS

The central point of this paper is to present the results of comparative meta-analysis concerning the impact of the interplay between formal and informal institutions in the corporate governance and independence of audit firms of Central and Eastern European Countries (CEECs). The paper focuses on the values of the national Financial Audit Law and national auditors’ code of ethics of CEECs, as well as on independence, professional scepticism, non-audit services, audit fees, mandatory audit firm rotation and joint carrying out of statutory financial audit. The main subject of interest concerns two research areas: the character of the relationship between formal and informal institutions, as well as whether the interplay between them is relevant to corporate governance and independence of audit firms of CEECs.

The perceived financial effects of mandatory audit firm rotation

AbstractThis paper explores the perceptions of key audit industry stakeholders concerning the direct and indirect financial effects of the implementation of mandatory audit firm rotation (MAFR) in South Africa. Globally, concerns over audit quality, in response to corporate failures, have resulted in renewed debate over MAFR as a solution. The European Union and South Africa have recently ruled in its favor, while other countries have rejected it on grounds that the benefits do not exceed the costs. Using structured surveys, the informed perspectives of experienced auditors, chief financial officers, audit committee chairs, and equity fund managers are explored and contrasted. We find that considerable costs will be imposed on audit firms in the form of “setup and transition costs,” as well as costs incurred to submit and present competitive tenders to secure appointment. Although auditors will try to recoup these costs with fee increases, this will likely not be allowed by the clients, resulting in a squeeze of audit firm profits. The Big 4 firm fee premium, relative to non‐Big 4 firms, will decrease due to increased competition. From the clients' perspective, the costs will be in the form of audit inefficiency translating into staff time and disruption, caused by the incoming auditors being less familiar with the complexities of the business. We contribute to the literature detailed descriptions and estimations of the nature and extent of potential cost implications, as expressed by experienced practitioners. The findings inform audit industry regulators, standard‐setters, and practitioners to more effectively mitigate potential unintended consequences of the regulation.

A theoretical approach to auditor independence and audit quality

Auditor independence and the quality of audit report is of growing concern to regulators, institutional investors and stakeholders as a series of accounting scandals have undermined the professionalism of auditors. The findings from this study produced an insight of how auditor’s independence improve audit quality and that abnormal audit fees is as a result of additional effort for auditor to carry out rigorous audit engagement as a result of wider audit scope; that mandatory audit firm rotation will enhance auditor independence, and that audit committee with nonexecutive independence will promote audit quality. The study also finds that in terms of auditor size, smaller audit firms that belong to professional bodies will provide higher audit quality. The main conclusion of this research is that where an auditor is fully independent in carrying out audit engagement with strong resistance to fees pressure will enhance audit quality. This research provides insight into the impact of IFRS adoption on audit fees.

Early Adopters of Mandatory Auditor Rotation and Audit Quality

Researchers and regulators have continuously debated whether mandatory audit firm rotation impacts audit quality. Theoretically, rotation might improve auditor independence but impair auditor competence. In 2014, the European Commission mandated audit firm rotation for public-interest entities, starting from 2020 for non-financial firms. However, in the transition period, any auditor change could already be interpreted in light of the upcoming mandatory regime, consistent with anecdotal evidence on such interpretations. These changes provide a unique setting because auditors have strong incentives to build a reputation for high-quality audits when choosing to participate in the market for rotations in the transition period. Using a balanced panel of 287 German firms and data from 2014 to 2019, we hypothesize and find lower discretionary accruals, abnormal working capital accruals, and total accruals in the first year after rotation. This effect is restricted to smaller public companies and does not persist in the following years.

Audit quality and independence concerns in the South African audit industry: Contrasting views

Audit quality in South Africa is perceived by the audit regulator to be deteriorating, with the primary cause being a compromise of auditor independence, mostly as a result of excessively long audit firm tenures. The regulator has responded with mandatory audit firm rotation (MAFR). The purpose of this research is to employ field surveys to collect the views of experienced audit committee (AC) chairs, chief financial officers (CFOs) and auditors of JSE-listed companies on the necessity for, and potential efficacy of, this regulation. An additional focus of the paper is to explore potential unintended outcomes, as well as identify preferred alternatives and provide recommendations and practical solutions to negative effects. Findings show that auditors, CFOs and AC chairs are strongly opposed to MAFR in South Africa on a cost-benefit analysis. Respondents do not believe that audit quality and independence has deteriorated and feel that existing measures to safeguard auditor independence are sufficient. In addition, the loss of knowledge and experience of the clients that will result from firm rotation, together with other unintended consequences such as unmanageable cost increases, provide further reasons not to implement MAFR. Findings also indicate that MAFR will not contribute towards decreasing the dominance of the market by the ‘Big 4’ firms. Practical recommendations are suggested based on the findings.

An Analysis of Mandatory Auditor Rotation Requirements in South Africa in light of International Legislative Trends

An independent and objective external audit of companies is an integral element of sound corporate governance and of functional financial markets. The issues relating to auditor independence and objectivity have attracted considerable regulatory and public scrutiny in many leading jurisdictions. This is partly due to a general decrease in audit quality over the years as evidenced by high-profile accounting scandals and audit failures, both locally and internationally, as well as the vital role that an external audit is expected to play in ensuring transparency, accuracy and efficiency in the financial markets. In an attempt to restore confidence in the audit profession and to strengthen the independence of the external audit function for companies, legislatures in some leading jurisdictions have introduced a variety of regulatory strategies, including mandatory rotation of auditors in the form of mandatory audit partner rotation (MAPR) and/or mandatory audit firm rotation (MAFR). In this article, the author examines the adequacy of the current provisions of section 92 of the Companies Act 71 of 2008 regarding MAPR and the recently promulgated rule of the Independent Regulatory Board for Auditors (IRBA) on MAFR (the MAFR rule) in addressing the issue of mandatory auditor rotation in South Africa. The author considers whether the provisions of the Companies Act 71 of 2008 regarding MAPR and the MAFR rule are adequate to promote an independent and objective external audit function for companies, as well as transparency, efficiency and accountability, while providing certainty for companies and auditors. The author first examines some of the key principles and policy considerations relating to the external audit of companies – namely, the significance of audits and auditors in the financial markets as well as the value of auditor independence and objectivity. This is followed by an examination of the provisions of section 92 of the Companies Act 71 of 2008 regarding MAPR and the recently promulgated MAFR rule in light of legislative developments in the United States, Canada, the European Union, Australia and India regarding mandatory rotation of auditors and audit partners. Based on the lessons to be drawn from the experiences of the above jurisdictions, the author then makes recommendations for appropriate reforms for South Africa in this important area of company law. This is followed by some concluding remarks.

Audit firm tenure and audit quality: A cross‐European study

AbstractDirective 2014/56/EU and Regulation (EU) No. 537/2014, which came into effect in June 2016, introduced the mandatory rotation of audit firms after a maximum period of 10 years with the same client. We conduct a cross‐European study with the aim of assessing whether long audit firm tenures are associated with lower levels of audit quality. The sample for the study is based on the constituents of the Standard & Poor's Europe 350 index for the years between 2009 and 2016, and we utilize three different sets of proxies for audit quality: discretionary accruals, differences between reported earnings and earnings benchmarks, and accounting restatements. The main result of the study finds that companies with more than 10 years of tenure with their auditors do not have a lower audit quality than other firms. In fact, this study provides some evidence of a higher audit quality for these firms. The results are robust to various checks. Therefore, if there does not seem to be a problem of a lack of audit quality associated with long audit firm tenures, the necessity of establishing a maximum tenure, as the new European regulation does, may be questioned.

An analysis of the possible impact of mandatory audit firm rotation on the transformation and market concentration of the South African audit industry

Orientation: Consistent with global concerns regarding the quality of audits and regulatory changes in Europe, South African audit regulations will require audit firms to rotate clients periodically, in an attempt to safeguard auditor independence and audit quality. In 2017 the South African audit regulator issued a ruling requiring mandatory audit firm rotation (MAFR) every 10 years, effective April 2023, primarily intended to improve audit quality. In addition to audit quality improvement, the regulator also believes that MAFR will stimulate transformation in the audit profession by building capacity of black-owned audit firms and allowing opportunities for small- and medium-tier audit firms to compete for the audits of listed companies. Research purpose: This study explores the perceptions of auditors and audit committee chairs of Johannesburg Stock Exchange-listed companies with regard to the direct and indirect financial effects of the implementation of MAFR in South Africa with respect to black economic empowerment and market concentration. Motivation for the study: No studies have explored this controversial additional objective of MAFR in South Africa. Research approach, design and method: An exploratory mixed-methods design is employed, using questionnaires derived from a review of the academic research and professional debate concerning MAFR. Main findings: Contrary to the intentions of the regulator, MAFR may not result in improved transformation of the audit profession and could in fact reduce the capacity of audit firms to pursue transformation initiatives. In addition, MAFR may not decrease the current degree of audit domination of the Big 4 firms of the JSE, possibly even further concentrating the industry, as audit committees and shareholders may be reluctant to appoint mid-tier firms as auditors of the large listed companies. Practical/managerial implications: Industry stakeholders and the regulator should consider targeted interventions to mitigate the potential for impaired transformation and further concentration of the industry which may result from implementation of MAFR in 2023. Contribution/value-add: The findings and conclusions will contribute to addressing concerns regarding the rate of black participation in the industry, as well as mitigating the potential unintended consequences of MAFR.

The Effect of Mandatory Audit Firm Rotation on Audit Quality, Audit Fees and Audit Market Concentration: Evidence from India

In India, the government introduced mandatory audit firm rotation following calls to improve audit quality and auditor independence in the wake of the Satyam accounting scandal. The absence of strong institutional mechanisms to prevent and detect audit failure in a timely manner has led the government to require periodical audit firm rotation. Evidence from firms for the years 2014 to 2017 suggests that mandatory audit firm rotation does not appear to have improved audit quality, reduced audit costs and increased audit market competition.