Are There Adverse Consequences of Mandatory Auditor Rotation? Evidence from the Italian Experience
39 Pages Posted: 14 Dec 2013 Last revised: 19 Mar 2017
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Are There Adverse Consequences of Mandatory Auditor Rotation? Evidence from the Italian Experience
Are There Adverse Consequences of Mandatory Auditor Rotation? Evidence from the Italian Experience
Date Written: December 12, 2013
Abstract
Mandatory auditor rotation was recently proposed for the European Union and is also under consideration in the United States. There has been little research into either the benefits or costs of rotation in a true mandatory setting that could inform intelligent policy making. Our paper helps fill this gap by examining Italy where mandatory rotation of auditors has been required since 1975. We find that outgoing auditors do not shirk on effort (or quality), but final year fees are 7 percent higher than normal which may indicate opportunistic pricing. The fees of incoming auditors are discounted by 16 percent even though they have abnormally higher engagement hours in the first year (17 percent), which is suggestive of low balling. However, subsequent fees are abnormally higher and exceed the initial fee discount. Thus the costs of mandatory rotation are nontrivial. Higher costs could be acceptable if rotation improves audit quality, but we find evidence of the opposite. Namely, the quality of audited earnings is lower in the first three years following rotation, relative to later years of auditor tenure. Since rotation is costly and earnings quality improves with longer auditor tenure, the evidence from Italy does not support the case for mandatory rotation.
Keywords: auditor rotation, audit fees, earnings quality, audit market regulation
JEL Classification: K22, L51, L80, M40
Suggested Citation: Suggested Citation