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 is moderated by the mental frame auditors adopt in evaluating managers’ representations. In practice, auditors can alternately frame their assessments of manager representations in terms of their potential honesty or potential dishonesty (a skepticism frame). Psychology theory suggests the auditor’s assessment frame may interact with the auditor’s experience with management, which varies according to auditor rotation. We conduct an experiment under the traditions of experimental economics to test for this interaction between auditor skepticism and mandatory rotation. We find that mandatory rotation improves audit quality when an auditor assesses management’s honesty. However, these effects reverse when an auditor takes a skeptical mindset. This unanticipated, harmful effect of rotation informs regulators, auditors and researchers interested in mandatory rotation and skepticism. The findings are robust to both high and low levels of informal interaction between auditors and management.

Number of Pages in PDF File: 47

Keywords: auditor rotation, professional skepticism, auditor-client relationship, auditor tenure

JEL Classification: C70, C90, G30, M42

working papers series