Mandatory Auditor Rotation Research Articles

Management of financial statements auditing in the Visegrad Group countries

This paper aims at comparing the management perspectives with the audit conditions in the Visegrad Group (V4) countries (the Czech Republic, the Slovak Republic, Poland, and Hungary) in the following areas: legislation governing the auditing, statutory duty of auditing, mandatory rotation of auditors in public interest entities, requirements on auditors and professional activities, and audit supervision organizations. The paper also tests the hypothesis whether there is a relationship between the size of the accounting entity and the auditor’s opinion.The methodology is based on the statistical analysis of the data using the Chi-square test of independence applied to a sample of 800 randomly selected accounting entities from all V4 countries (200 per each country in question).The results demonstrated significant differences in the management approaches to financial reporting, especially in the area of the statutory duty of auditing. In addition, quantitative research was conducted to determine whether there is a relationship between the size of the accounting entity and the auditor’s opinion. At the 5% significance level, no such dependence has been found for any of the V4 countries, but at the 10% significance level, the dependence has already been proved in case of the Republic of Poland and Hungary. The practical value of the obtained results is the knowledge of how to manage accounting standards for business entities in the V4 countries, as well as to determine the statutory duty to audit financial statements. These results might be of a special practical importance for business managers, tax authorities, and auditors operating in the EU countries.

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.

Empirical Evidence on Audit Quality Under a Dual Mandatory Auditor Rotation Rule

Regulators in the US ruled against introducing mandatory firm rotations in addition to the existing rule for periodic partner rotations. In contrast, European regulators ruled in favour of a dual mandatory rotation rule in which both audit firm and audit partner rotations are required. Employing a unique setting where a dual regime of audit and firm rotations are required, we assess the net benefit (cost), of audit firm rotation incrementally to partner rotation. Specifically, we analyse several earnings-based measures of audit quality along with the market perception of audit quality. Controlling for partner rotation, we do not find that firm rotations have a positive incremental effect. In contrast, we find audit partner rotation under the dual regime appears to improve both the earnings-based measures of audit quality, and market perceptions of earnings. Our evidence suggests that any benefit arising from dual rotation is likely to be driven by the change in partner. However, whether the audit firm rotation should still be required is unclear, given that the observed benefits arising from the audit partner rotation could potentially be preconditioned on audit firm rotation.

Enhancement of Audit Quality Through Audit Firm Rotation (Case Study Selected Commercial Banks in Ethiopia)

The purpose of this study is to examine the Audit Firm Rotation and Audit Quality using Evidence from selected Ethiopia Commercial Banks in Addis Abeba, Ethiopia. The main objective of the study is to examine the extent that audit firm rotation significantly affects audit quality, and to evaluate the relationship between board independence and audit quality. The possibility of enhancing audit quality through audit firm rotation is a key method used by regulatory body. This study intended to assess the applicability of the mandatory auditor rotation concept in the Ethiopian banking sector so as to enhance and improve audit quality, from the findings of both the literature as well as the field survey, it was discovered that audit firm rotation significantly affect audit quality. It was concluded that rotation is a good solution to enhance Audit quality and also to maintain the auditor independence by decreasing the audit firm’s dependence on the client. Recommendations were made based on the findings that the regulatory bodies such as National Bank of Ethiopia, Federal Auditor General should make a laws that will appreciate audit firm rotation in order to improve audit quality, also the National Bank of Ethiopia should think of possible other ways of addressing the concept of audit quality. Keywords: Audit Quality, Audit Firm Rotation, Audit Fee, National Bank of Ethiopia. DOI : 10.7176/RJFA/11-1-04 Publication date: January 31 st 2020

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 Retendering and Mandatory Auditor Rotation

Building on an auction model, we examine the economic consequences of audit retendering, under which the incumbent auditor in auction possesses both an information advantage and knowledge advantage over outside auditors. Audit retendering allows the firm to retain the incumbent auditor with positive probability, but expect to pay information rent to the incumbent auditor due to his information advantage over outside auditors. In equilibrium, auditor switching (or no switching) under audit retendering conveys additional information to investors, and therefore the informativeness of the audit report under audit retendering is always greater than that under mandatory auditor rotation. We identify conditions under which client firms may benefit from audit retendering. Our findings shed light on the recent European Union Audit Reform, which adopts audit retendering as an alternative to auditor rotation, and have implications to the Public Company Accounting Oversight Board, which are evaluating the proposed mandatory auditor rotation.

감사인 강제교체 기업과 조세회피－세무조정 비감사서비스 제공을 중심으로－

감사인 강제교체 기업과 조세회피－세무조정 비감사서비스 제공을 중심으로－

Corporate governance failure at Ricoh India: rebuilding lost trust

Subject area The case “Corporate Governance Failure at Ricoh India: Rebuilding Lost Trust” discusses the series of events post disclosure of falsification of the accounts and violation of accounting principles, leading to a loss of INR 11.23bn for the company, eroding over 75 per cent of its market cap (Financial Express, 2016). The case provides an opportunity for students to understand the key components of corporate governance structure and consequences of poor corporate governance. The case highlights the responsibility of the board of directors, audit committee and external auditors and discusses the changes required in the corporate governance structure necessary to ensure that such incidents do not take place. The case also delves into the classic dilemma of degree of control that needs to be exercised by the parent over its subsidiaries and freedom of independence given to the subsidiary board, which is a constant challenge all multinationals face. Such a dilemma often leads to the challenge of creating appropriate corporate governance structures for numerous subsidiaries. Study level/applicability The case is intended for MBA courses on corporate governance, business ethics and also for the strategic management courses in the context of multinational corporations. The case can be used to develop an understanding of the essential of corporate governance with special focus on the role of the board of directors, audit committee and external auditors. The case highlights the consequences and cost of poor corporate governance. The case can also be used for highlighting governance challenges in the parent subsidiary relationship for multinational corporations. The case can be used for executive training purposes on corporate governance and leadership with special focus on business ethics. Case overview This case presents the challenges faced by the newly appointed Chairman Noboru Akahane of Ricoh India. In July 2016, Ricoh India, the Indian arm of Japanese firm Ricoh, admitted that the company’s accounts had been falsified and accounting principles violated, leading to a loss of INR 11.23 bn for the financial year 2016. The minority shareholders were agitating against the board of directors of Ricoh India and were also holding the parent company responsible for not safeguarding their interest. Over a period of 18 months, Ricoh India had been in the eye of a storm that involved delayed reporting of financials, auditor red flags regarding accounting irregularities, a forensic audit, suspension of top officials and a police complaint lodged by Ricoh India against its own officials. Akahane needed to ensure continuity of Ricoh India’s business and also act quickly and decisively to manage the crisis and ensure that these incidents did not recur in the future. Expected learning outcomes The case provides an opportunity for students to understand the key components of corporate governance structure and consequences of poor corporate governance. More specifically, the case addresses the following objectives: provide an overview of corporate governance structure; highlight the role of board of directors, audit committee and external auditors; appreciate the rationale behind mandatory auditor rotation; appreciate the consequences of poor corporate structure; explore the interrelationship between sustainability reporting and transparency in financial disclosures of a corporation; understand management and governance of subsidiaries by multinational companies; and understand the response to a crisis situation. Supplementary materials Teaching notes are available for educators only. Please contact your library to gain login details or email support@emeraldinsight.com to request teaching notes. Subject code CSS 11: Strategy.

Disciplining Role of Auditor Tenure and Mandatory Auditor Rotation

This study addresses the international debate over whether the rotation of audit firms should be mandatory. Mandatory rotation rules have been adopted by the European Union, but have not been established in the United States. Proponents of the policy believe that a long tenure auditor-client relationship leads to the auditor building an excessive economic bond with the client which erodes auditor independence. Motivated by this claim, I build a theoretical model that compares auditor incentives to issue independent reports under the regimes with and without mandatory rotation. The model demonstrates conditions under which mandatory rotation could actually impair auditor independence, contrary to the popular view.

Audit firm tenure, auditor familiarity, and trust: Effect on auditee whistleblowing reporting intentions

Mandatory audit firm rotation has been researched for decades with resulting opposition as well as support. Research has mainly treated mandatory auditor rotation at the firm macro level. We submit the client relationship length is comprised of firm tenure and audit team continuity, or auditor familiarity. Increased tenure, at the interorganizational or firm level and interpersonal or individual level, has been shown to increase trust; and further, trust is positively related to employee voice, such as speaking up about fraud (whistleblowing). We conduct an experiment examining whether increased audit firm tenure and auditor familiarity leads to increased trust, which enhances the willingness to whistleblow. We find evidence that suggests auditor familiarity enhances trust, which, in turn, positively influences an employee's intentions to whistleblow. This has important implications for the profession and for future research exploring mandatory audit firm rotation; in particular, the need to include auditor familiarity as a construct.

Auditor Tenure, Information Asymmetry and Earnings Quality

We confirm the results of prior studies that auditor tenure improves earnings quality on average. We extend their findings to show that the improvement in earnings quality resulting from longer auditor tenure is greater for firms with higher information asymmetry, after controlling for auditor’s industry specialization. We argue that audits of client firms with higher information asymmetry demand more client specific knowledge that cannot be gleaned from industry or general experience. Longer tenure helps auditors acquire such knowledge and therefore, the benefit of longer audit tenure is greater in firms with greater information asymmetry. We use bid-ask spread, return volatility, intensity of R&D expenditure and a composite distance measure to measure information asymmetry. Our results imply that frequent auditor changes are costlier for firms with higher information asymmetry. At the policy level, our results imply that mandatory auditor rotation is more (less) costly for firms with high (low) information asymmetry.

Developments in France regarding the mandatory rotation of auditors: Do they enhance auditors’ independence?

Mandatory rotation of auditors or of audit firms has been the subject of extensive debate among academics, professionals, and regulators, especially since the financial crisis of the 2000s. Does rotation enhance auditors’ independence and audit quality? The research evidence on the impact of mandatory audit firm rotation on audit quality and auditor independence is inconclusive. This article offers a historical approach to understanding the implementation of mandatory rotation, based on the French case. The auditing profession in France is strongly regulated, with four main provisions designed to reinforce auditors’ independence: prohibitions on a priori and a posteriori incompatibilities, a 6-year audit tenure, a ban on non-audit services, and the use of joint audit. The rotation of auditors was merely an additional and non-compulsory tool. However, in 2014, the European Commission decided to implement the mandatory rotation of audit firms despite the opposition of the French accounting profession and regulators. Does this suggest that the French model was ineffective? It probably does not. In this specific context of France, a mandatory rotation of audit firms would seem unlikely to enhance audit quality.

Auditor Tenure and Perceived Earnings Quality

The study examines how auditor tenure affects investors' perception of audit quality. It is motivated by the ongoing debate on the effect of auditor tenure on audit quality and the recent regulation approval on mandatory auditor rotation at the EU level, which is justified by the concern that longer auditor tenure impairs auditor independence and thus lowers audit quality. Perceived earnings quality, as measured by the earnings response coefficient from returns‐earnings regression, is used as a proxy for investors’ perception of audit quality. Using a sample of 2,320 firm‐year observations from German listed firms between 2006 and 2013, the study provides evidence of a non‐linear relationship between auditor tenure and perceived earnings quality. The results suggest that investors perceive lower earnings quality during the early and later years of an auditor–client relationship. This perception does not change during the investigation period. Furthermore, the results show that earnings quality is perceived as highest when auditor tenure is 8–9 years.

Auditor tenure and accounting conservatism: evidence from Greece

Purpose This study aims to examine the relationship between auditor tenure and conservatism for firms in Greece. Greece not only has a high incidence of earnings management but is also required under the new European Commission (EC) regulation to comply with mandatory auditor rotation. Therefore, Greece is an ideal setting in which to study the association between auditor tenure and accounting conservatism. Design/methodology/approach Similar to Jenkins and Velury (2008), this paper uses Basu’s (1997) asymmetrical timeliness of earnings as a measure of conservatism. Following Li (2010), the regression is re-estimated for subsamples based on client importance as measured by the ranking of client sales among all clients audited by the firm. Findings In contrast to Li (2010), the results of this study, which used a sample of firms in Greece, indicate that conservatism decreases as the auditor–client relationship lengthens. Client importance does not appear to affect the relationship between auditor tenure and conservatism, as measured by asymmetric timeliness of earnings. However, when using the accrual–cash flow measure of conservatism (Ball and Shivakumar, 2005), it is found that auditor tenure is positively (negatively) associated with conservatism for less (more) important clients. The results suggest that longer auditor tenure may have a negative impact on audit quality in certain countries where accounting quality has been found to be poor. Therefore, the new EC regulation requiring mandatory auditor rotation may in fact improve audit quality for firms in Greece. Research limitations/implications This study’s sample consists of firms on the Athens Stock Exchange for the period of 1998-2011. This sample was purposely selected because of the unique conditions of rampant earnings management and low incentive in Greece for the auditors to exert effort to detect such practices. Moreover, Greece is subject to the new EC regulations requiring mandatory auditor rotation beginning in 2014. Future studies could examine this issue in alternate settings and over different time periods. Also, other cross-sectional variations among firms which affect the association between auditor–client tenure and audit quality may exist. Practical implications The findings are important to regulators such as the EC and indicate that Greece may be an appropriate setting in which to require mandatory auditor rotation. These results are also useful to auditors who wish to improve the audit quality and the public’s perception of their work. Originality/value Auditor tenure has been the subject of considerable debate, and regulators contend that long auditor tenure reduces audit quality. There may be a valid argument in favor of mandatory auditor rotation in countries particularly susceptible to low accounting quality due to issues such as rampant earnings management. Greece appears to be one such example, and this study provides support in favor of that argument by demonstrating that longer auditor tenure may lead to lower accounting quality in terms of conservatism. Therefore, the recent EC regulation may result in improved audit quality for firms in Greece.

Audit Report Lag , Audit Tenure and Auditor Industry Specialization : Empirical Evidence from Jordan = فترة إصدار تقرير مدقق الحسابات ، فترة الاحتفاظ بالمدقق و وجود التخصص في التدقيق : دليل تجريبي من الأردن

This study examined the association between audit-firm tenure and audit report lag (ARL) and how this association is affected by auditor industry specialization. Using two methods for measuring auditor industry-specialization, the study sample included 691 Jordanian firm year observations listed in Amman Stock Exchange during the period (2009-2013). The data collected was analyzed by using a number of basic statistical techniques such as descriptive statics, correlation and multiple-regression. This study revealed thatthere is no significant relationship between audit report lag and audit tenure. Additionally, industry specializations auditors will not influence on the relation between audit report lag and audit tenure in Jordan. Policy makers and regulators are encouraged to take into consideration that mandatory auditor rotation in Jordan will not result in longer audit report lag. Although audit industry specialization didn’t influence on the relation between audit report lag and audit tenure, auditor industry specialization has a significant effect on audit report lag, therefore, the Jordanian companies are recommended to hire industry-specialized auditors to reduce audit report lag. The researchers also recommend farther researches with different measurements of auditor industry specialization

An Analysis of Auditor's Learning Costs and Non-Audit Services on Audit Quality

This study uses a very simple but intuitive model to examine how audit quality is determined. It concludes that audit quality is higher if two forces have opposite effects on an auditor’s conservatism are balanced and significant. A force that makes an auditor less conservative is the benefit from future engagements with a client, while the force that makes the auditor more conservative is the expected liabilities from overstated accounting values. Given that the expected auditor’s liabilities from overstated accounting values are usually significant, we find that significant rents from future engagements with a client improve audit quality through inducing greater audit efforts and less biased reports. Our analysis suggests that learning costs and non-audit services would be sources for these future rents, and auditors should be allowed to provide non-audit services to their clients and these revenues should be higher as auditor tenure lengthens. Furthermore, our analysis shows that mandatory auditor rotation is detrimental to audit quality since it reduces the future rents to auditors which lead to lower audit effort and more biased report. Finally, well-developed auditing standards need to be properly enforced by the regulator/profession for auditors to render appropriate audit quality when the costs associated with over and under reporting are low and/or not balanced.

Evaluating Market-Based Corporate Governance Reform: Evidence from a Structural Analysis of Mandatory Auditor Rotation

Many current reform proposals of corporate governance involve financial market intervention as an external governance device. Among them, mandatory audit firm rotation has been controversial. This paper empirically evaluates and quantifies the economic impact of mandatory audit firm rotation using a structural approach, focusing on the critical role played by firms’ existing internal governance. My counterfactual analysis suggests that (1) mandatory audit firm rotation can reduce the shareholder value by 5.9 to 7.2 billion dollars for the US public firm in my sample; (2) a significant fraction of the reduction results from reduced board effectiveness in selecting desirable auditors and hence the policy is more costly to the shareholders of the firms with strong internal governance; (3) policies that improve firm internal governance can work better and increase shareholder value; and (4) mandatory rotation becomes even more costly and further increases the cost of reduced board effectiveness by approximately 4.0 percent when firm internal governance improves and the board interests become fully aligned with shareholder interests. These findings highlight the cost of mandatory audit firm rotation and that the proposed rotation may counteract other policies intended to improve internal corporate governance.

Audit Firm Tenure, Bank Complexity and Financial Reporting Quality

Theory from organizations and economics research posits that in an inter-organizational exchange relationship, learning leads to relationship-specific investments that facilitate the effectiveness of the relationship while strengthening the attachment between the exchange parties. In complex settings where the opportunities for learning are greater, the investments will be larger and the attachment stronger. Because banks are complex institutions that present unique challenges to auditors, we argue that an effective audit critically depends on the accumulation of significant investments in client-specific expertise through a long association with the client. Thus, we expect that in banks a long audit firm tenure is positively associated with financial reporting quality and we expect this association to be particularly strong in more complex banks. Our findings are consistent with these expectations. In addition, contrary to prior research we find that benefits to a long tenure for complex banks accrue even for very long tenures and are not limited to intermediate tenures. Our findings largely support the notion that a long association with the client reflects the underlying demand for expertise, which is critical for the delivery of high quality audits in complex organizations. Imposing short-term limits on auditors would adversely impact the investments in client-specific expertise especially in the cases where this expertise is needed the most. Our findings do not support calls for imposing mandatory rotation of auditors among large complex institutions.

Auditor Independence and Mandatory Auditor Rotation in Jordan

Purpose: The purpose of this study is to test the relationship between auditor rotation and the level of auditor independency, and to investigate, the impact of auditor rotation, audit fees, audit tenure and the relationship with client on the auditor independency in Jordanian audit firms. Furthermore, to identify the reasons behind rotating the auditor and the advantages/disadvantages of auditor rotation. Design/methodology/approach: The study has been carried out through a questionnaire survey that aimed to collect data about the auditor independency in Jordan, and through a developed model to test the mandatory auditor rotation in the Jordanian audit firms. Findings: After defining the four independent main variables of the auditor independency (auditor-client relationship, audit tenure, audit fees, and mandatory auditor rotation). The findings of the study revealed that there is a significant positive relationship between the auditor independency and auditor-client relationship and mandatory rotation. A negative one with the audit fees and there is no relationship with audit tenure. Research limitations/implications: This paper has some limitations such as, some audit firms refused to allow researchers to distribute the questionnaire which is not familiar in Jordan. Originality Value: This paper contributes to the understandings of the nature and characteristics of the auditor independency by empirically exploring the nature and characteristics of mandatory auditor rotation in Jordan.

The Effects of Auditor Rotation, Professional Skepticism, and Interactions with Managers on Audit Quality

ABSTRACT We examine whether the effect of mandatory auditor rotation on audit quality depends on the mental frame auditors adopt in evaluating management representations. In practice, auditors can alternately frame their assessments of management representations in terms of their potential dishonesty (what we term skepticism) or potential honesty. Using psychology theory and a laboratory experiment, we predict and find that mandatory rotation improves audit quality when an auditor takes an honesty frame, but that this effect reverses when an auditor takes a skeptical frame. Thus, the benefit of using a skeptical frame occurs when auditors do not rotate, but requiring rotation can reduce audit effort for auditors using a skeptical frame. An implication of our study is that focusing auditors on a skeptical assessment frame rather than mandating auditor rotation may be a less costly way to reduce low-effort audits and aggressive reporting.