Zimbabwean Stakeholder Perceptive of How Mandatory Audit Firm Rotation Contribute to Audit Quality

AbstractThe 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.

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

Managerial Auditing Journal ◽

10.1108/maj-09-2019-2405 ◽

2020 ◽

Vol 35 (7) ◽

pp. 861-896

Author(s):

Michael Harber ◽

Warren Maroun

Keyword(s):

Audit Committee ◽

Audit Quality ◽

Unintended Consequences ◽

Policy Implications ◽

Chief Financial Officers ◽

Structured Interviews ◽

Design Data ◽

Content Type ◽

Audit Firm ◽

Mandatory Audit Firm Rotation

Purpose This 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/approach Using 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. Findings Practitioners 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 implications The 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/value The 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.

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Audit Firm Tenure and Fraudulent Financial Reporting

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2004.23.2.55 ◽

2004 ◽

Vol 23 (2) ◽

pp. 55-69 ◽

Cited By ~ 318

Author(s):

Joseph V. Carcello ◽

Albert L. Nagy

Keyword(s):

Financial Reporting ◽

Audit Quality ◽

Auditor Independence ◽

Fraudulent Financial Reporting ◽

Audit Firm ◽

Auditor Tenure ◽

Sarbanes Oxley ◽

Client Relationship ◽

Mandatory Audit Firm Rotation ◽

The U.S

The Sarbanes-Oxley Act (2002) required the U.S. Comptroller General to study the potential effects of requiring mandatory audit firm rotation. The General Accounting Office (GAO) concludes in its recently released study of mandatory audit firm rotation that “mandatory audit firm rotation may not be the most efficient way to strengthen auditor independence” (GAO 2003, Highlights). However, the GAO also suggests that mandatory audit firm rotation could be necessary if the Sarbanes-Oxley Act's requirements do not lead to improved audit quality (GAO 2003, 5). We examine the relation between audit firm tenure and fraudulent financial reporting. Comparing firms cited for fraudulent reporting from 1990 through 2001 with both a matched set of non-fraud firms and with the available population of non-fraud firms, we find that fraudulent financial reporting is more likely to occur in the first three years of the auditor-client relationship. We fail to find any evidence that fraudulent financial reporting is more likely given long auditor tenure. Our results are consistent with the argument that mandatory audit firm rotation could have adverse effects on audit quality.

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The relation of auditor tenure to audit quality: Empirical evidence from the German audit market

Journal of Governance and Regulation ◽

10.22495/jgr_v2_i1_p2 ◽

2013 ◽

Vol 2 (1) ◽

pp. 27-43 ◽

Cited By ~ 4

Author(s):

Patrick Krauß ◽

Henning Zülch

Keyword(s):

Audit Quality ◽

The European Union ◽

Short Term ◽

Audit Firm ◽

Audit Market ◽

Auditor Tenure ◽

Client Relationship ◽

Mandatory Audit Firm Rotation

This study investigates whether and how the length of an auditor-client relationship affects audit quality. Using a sample of 1,071 firm observations of large listed companies for the sample period of 2005 to 2011, the study is one of the first to empirically analyze this auditing issue for the German audit market. The empirical results demonstrate that neither short term nor long term audit firm tenure seems to be a significant factor with regard to audit quality in Germany. In the wake of the ongoing discussion in the European Union regarding the optimal audit tenure length for the quality of the conducted statutory audits, our findings do not support the idea of a mandatory audit firm rotation rule.

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Investor Reaction to the Prospect of Mandatory Audit Firm Rotation

The Accounting Review ◽

10.2308/accr-51488 ◽

2016 ◽

Vol 92 (1) ◽

pp. 183-211 ◽

Cited By ~ 22

Author(s):

Lauren C. Reid ◽

Joseph V. Carcello

Keyword(s):

Audit Quality ◽

Market Reaction ◽

Abnormal Returns ◽

Data Availability ◽

Control Group ◽

Cross Sectional ◽

Audit Firm ◽

Auditor Tenure ◽

Big 4 ◽

Mandatory Audit Firm Rotation

ABSTRACT The PCAOB recently considered implementing mandatory audit firm rotation in hopes of better aligning auditors' interests with investors' interests, suggesting that the PCAOB views long auditor tenure as problematic. However, the accounting profession argues that long tenure actually improves audit quality. This study provides insight into investors' views by evaluating the market's reaction to events related to the potential adoption of rotation that occurred between 2011 and 2013. The results provide some evidence that the market reacts negatively (positively) to events that increased (decreased) the likelihood of rotation, although these results are sensitive to the market index used to calculate abnormal returns. More importantly, particularly given the lack of a U.S.-specific control group, cross-sectional tests provide strong evidence that the market reaction is more negative (positive) on dates that increased (decreased) the likelihood of rotation given longer auditor tenure. Moreover, we also find that the market reaction is more negative (positive) on dates that increased (decreased) the likelihood of rotation given a Big 4 auditor. Data Availability: Data are available from public sources identified in the text.

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Mandatory Audit Firm Rotation and Audit Quality

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v31i3.9245 ◽

2015 ◽

Vol 31 (3) ◽

pp. 1089 ◽

Cited By ~ 10

Author(s):

Hakwoon Kim ◽

Hyoik Lee ◽

Jong Eun Lee

Keyword(s):

Audit Quality ◽

Global Financial Crisis ◽

Auditor Independence ◽

Financial Statement ◽

Policy Makers ◽

Audit Firm ◽

Going Concern ◽

Financial Statement Audit ◽

Mandatory Audit Firm Rotation ◽

First Time

Recently, regulators and policy makers who witnessed the global financial crisis during 20072009 began considering a variety of ways to enhance auditor independence and financial reporting quality, ultimately aiming at investor protection. Since the enactment of the SarbanesOxley Act of 2002 (SOX), the Mandatory Audit Firm Rotation (MAFR) requirement has once again received significant attention from regulators and policy makers around the world, including the European Union (EU) and the U.S. Public Companies Accounting Oversight Board (PCAOB). In this paper, we investigate whether MAFR enhances audit quality in Korea. We find that under MAFR, newly rotated auditors are more likely to issue first-time going-concern audit opinions to financially distressed firms during their initial (first-year) financial statement audit compared with under the Voluntary Audit Firm Change (VAFC). Moreover, firms audited by mandatorily rotated new auditors have less discretionary accruals and higher accrual quality than those audited by voluntarily switched new auditors during the initial audit engagement. These results of earnings quality are more pronounced for firms that received a first-time going-concern audit opinion during the initial financial statement audit under MAFR. Taken together, the findings suggest that MAFR produces better audit quality than the VAFC. Further, our study provides implications for regulators and policy makers of countries considering the adoption of MAFR.

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Mandatory audit firm rotation and audit quality

Managerial Auditing Journal ◽

10.1108/02686900810875271 ◽

2008 ◽

Vol 23 (5) ◽

pp. 420-437 ◽

Cited By ~ 70

Author(s):

Andrew B. Jackson ◽

Michael Moldrich ◽

Peter Roebuck

Keyword(s):

Audit Quality ◽

Audit Firm ◽

Mandatory Audit Firm Rotation

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Auditor’s Professional Specialization Role in Reducing the Potential Negative Effects of Mandatory Audit-Firm Rotation on Audit Quality

Journal of Accounting & Marketing ◽

10.4172/2168-9601.1000252 ◽

2017 ◽

Vol 06 (03) ◽

Author(s):

Mohamed A Elshawarby

Keyword(s):

Audit Quality ◽

Negative Effects ◽

Audit Firm ◽

Mandatory Audit Firm Rotation

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How Investors Perceive Mandatory Audit Firm Rotation in Korea

Sustainability ◽

10.3390/su11041089 ◽

2019 ◽

Vol 11 (4) ◽

pp. 1089 ◽

Cited By ~ 2

Author(s):

Sook Kim ◽

Seon Kim ◽

Dong Lee ◽

Seung Yoo

Keyword(s):

Audit Quality ◽

Indirect Evidence ◽

Auditor Independence ◽

Equity Capital ◽

Cost Of Equity Capital ◽

Cost Of Equity ◽

Audit Firm ◽

The Cost ◽

Mandatory Audit Firm Rotation ◽

The Impact

Credible audit quality is a precondition for a firm’s sustainability. External auditors offer assurance with regard to the uncertain factors that can jeopardize a firm’s sustainability and provide audit opinions that help investors assess risk. After the global crisis and accounting scandals, mandatory audit firm rotation has been implemented globally. However, few studies have investigated either the cost or the benefit of mandatory audit firm rotation. Prior studies provide only indirect evidence on the effects of audit firm tenure on audit quality/perceived audit quality. By discussing prior arguments, we examine how investors perceive the implementation of mandatory audit firm rotation in Korea. Using a unique and direct setting to examine our research question, we analyze the relationship between firms with mandatorily switched audit firms and the cost of equity capital from 2006 to 2008. We find that the mandatory change in the auditors has a negative association with the cost of equity capital. The results are robust to using the arithmetic mean of the cost of equity capital, lagged control variables, and the manufacturing industry effect. The results indicate that investors perceive that mandatory audit firm rotation provides an environment for qualified audits by enhancing auditor independence and skepticism, and thus decreases the cost of equity capital. This study helps to improve our understanding of the impact of mandatory audit firm rotation the information risk evaluations and provides political implications for policy makers by showing the benefit of mandatory audit firm rotation.

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Estimates of Optimal Audit Firm Tenure Across Different Legal Regimes

Journal of Accounting Auditing & Finance ◽

10.1177/0148558x16641864 ◽

2016 ◽

Vol 32 (1) ◽

pp. 3-39 ◽

Cited By ~ 8

Author(s):

Li (Lily) Z. Brooks ◽

C. S. Agnes Cheng ◽

Joseph A. Johnston ◽

Kenneth J. Reichelt

Keyword(s):

Quadratic Form ◽

Audit Quality ◽

Investor Protection ◽

Optimal Point ◽

Audit Firm ◽

Country Level ◽

Legal Regimes ◽

Key Variables ◽

Mandatory Rotation ◽

Mandatory Audit Firm Rotation

Based on a quadratic form of audit tenure in explaining audit quality, we estimate a reference point that is potentially optimal for audit firm rotation for 22 countries across legal regimes with high versus low levels of investor protection. We find that our estimate for the high investor protection regime is longer than that for the low investor protection regime (24 years vs. 14 years for our main measure). However, very few firms from our sample would have been affected if there were a requirement of a mandatory rotation term, suggesting that mandatory audit firm rotation may not be necessary. In additional analyses, we not only evaluate the empirical validity of the quadratic form but also use various measures of our key variables, to conduct several other robustness tests. We continue to find a longer optimal point for countries with stronger investor protection in these robustness tests. Our findings imply that stronger country-level investor protection is a substitute for a shorter term of mandatory audit firm rotation.

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