Does Mandatory Audit Firm Rotation Harm or Benefit Non-Big 4 Audit Firms? An Analytical Investigation
54 Pages Posted: 6 Jun 2017 Last revised: 30 Jan 2020
Date Written: October 11, 2019
Abstract
Because mandatory audit firm rotation (MAR) limits the economic rents earned from a client, regulators regard MAR as a means to address the threat of impaired auditor independence. Moreover, regulators expect that MAR increases the dynamism of the audit market and decreases the market shares of the Big 4 audit firms. However, especially the expectation regarding the effects of MAR on the audit market is very controversial. This paper uses an analytical model that accounts for the endogenous auditor-client matching to examine this topic. The results indicate that MAR weakens the Big 4 audit firms’ market dominance only if the non-Big 4 audit firms’ market shares before the implementation of MAR are sufficiently large. If, in contrast, the non-Big 4 initially have small market shareswhich is the empirical observation for most national audit markets and segments the implementation of MAR further increases concentration. Additionally, MAR does not achieve the intended reduction in client importance for the Big 4 or the non-Big 4 audit firms with initially small market shares. The results show that the effects of MAR on market concentration and client importance are not clear-cut, but crucially depend on the market structure that is prevalent before the regulation’s implementation.
Keywords: audit market concentration, auditor-client matching, client importance, mandatory audit firm rotation, market-matching model
JEL Classification: D43, L11, M42
Suggested Citation: Suggested Citation