Audit Partner Rotation, Earnings Quality and Earnings Conservatism

42 Pages Posted: 10 Jun 2005

See all articles by Jane Hamilton

Jane Hamilton

La Trobe University

Caitlin M. S. Ruddock

UNSW Australia Business School, School of Accounting

Donald J. Stokes

Monash University

Stephen L. Taylor

University of Technology Sydney; Financial Research Network (FIRN); Centre for International Finance and Regulation (CIFR)

Date Written: June 9, 2005

Abstract

We provide evidence of an association between audit partner rotation and the quality of earnings. It is a requirement for Australian firms that the engagement partner be identified by name in the annual report. Using a sample of 3,621 firm-years between 1998 and 2003, we show that audit partner changes most likely reflecting partner rotation (i.e., they are not due to a switch of audit firm) are associated with lower signed unexpected accruals, and that for Big 5 clients this relation is driven by smaller positive unexpected accruals following partner changes. This result is consistent with more conservative reporting following a rotation of audit partner, and this interpretation is further supported by evidence suggesting a significant increase in the asymmetrically timely recognition of economic losses when firms have a change of audit partner. Our tests also show that these effects occur predominantly among clients of Big 5 audit firms, and that any effect is concentrated in the latter part of our sample period, when partner rotation was a professional requirement. We therefore conclude that audit partner rotation is associated with incrementally greater conservatism in financial reporting, but only in circumstances where the ability of client firms to resist partner rotation is reduced by mandatory partner rotation requirements.

Keywords: Partner rotation, auditor independence, earnings quality, audit quality

JEL Classification: M41, M44, M49, G34, G38

Suggested Citation

Hamilton, Jane Maree and Ruddock, Caitlin M. S. and Stokes, Donald and Taylor, Stephen L., Audit Partner Rotation, Earnings Quality and Earnings Conservatism (June 9, 2005). Available at SSRN: https://ssrn.com/abstract=740846 or http://dx.doi.org/10.2139/ssrn.740846

Jane Maree Hamilton

La Trobe University ( email )

PO Box 199
Bendigo, Victoria 3550
Australia
61 3 54447292 (Phone)
61 3 54 447998 (Fax)

Caitlin M. S. Ruddock

UNSW Australia Business School, School of Accounting ( email )

Sydney, NSW 2052
Australia
+612 9385 5806 (Phone)
+612 9385 5925 (Fax)

Donald Stokes

Monash University ( email )

Department of Accounting and Finance
P O Box 197
Caulfield East, Victoria 3145
Australia

Stephen L. Taylor (Contact Author)

University of Technology Sydney ( email )

UTS Business School
PO Box 123 Broadway
Sydney, NSW 2007
Australia
61295143437 (Phone)
61295143513 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Centre for International Finance and Regulation (CIFR) ( email )

Level 7 UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

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