Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

47 Pages Posted: 19 Jun 2013

See all articles by Gil S. Bae

Gil S. Bae

Korea University - Department of Accounting

Sanjay Kallapur

Indian School of Business

Joon Rho

Chungnam National University - College of Business

Date Written: June 18, 2013

Abstract

In this paper we provide evidence on specific factors that could affect audit quality under mandatory rotation, using data from Korea where mandatory auditor rotation was put into effect in 2006. We find no evidence supporting the “Brillo pad effect” (the argument that departing auditors have incentives to clean up the balance sheet) or the “new broom effect” (the argument that new auditors can find problems that long-standing auditors tend to overlook). On the contrary, departing auditors spend fewer hours just before rotation, consistent with a lack of incentives to maintain quality given the impending rotation. Compared to clients in other mandatory rotations, the clients rotating away from industry specialist auditors have higher audit hours and higher absolute discretionary accruals post-rotation, suggesting there are adverse effects from breaking such auditor-client pairings. Finally we find that Big 4 auditors’ market share continues to increase after mandatory rotation is imposed. Our findings therefore fail to support mandatory rotation.

Keywords: Mandatory auditor rotation, Audit quality, Industry expertise, Market share

JEL Classification: M4, M49

Suggested Citation

Bae, Gil Soo and Kallapur, Sanjay and Rho, Joon, Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea (June 18, 2013). Indian School of Business, Available at SSRN: https://ssrn.com/abstract=2281127 or http://dx.doi.org/10.2139/ssrn.2281127

Gil Soo Bae

Korea University - Department of Accounting ( email )

Seoul, 136-701
Korea

Sanjay Kallapur (Contact Author)

Indian School of Business ( email )

ISB Campus, Gachibowli
Hyderabad, 500 032
India
+91 40 2318 7138 (Phone)

Joon Rho

Chungnam National University - College of Business ( email )

Daejon
Korea

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