Mandatory Audit Firm Rotation and Audit Quality

Posted: 6 Apr 2014

See all articles by Mara Cameran

Mara Cameran

Bocconi University - Department of Accounting

Annalisa Prencipe

Bocconi University - Department of Accounting

Marco Trombetta

IE Business School - IE University

Date Written: April 4, 2014

Abstract

In a setting where mandatory audit firm rotation has been effective for more than 20 years (i.e., Italy), we analyse changes in audit quality during the auditor engagement period. In our research setting, auditors are appointed for a three-year period and their term can be renewed twice up to a maximum of nine years. Since the auditor has incentives to be reappointed at the end of the first and the second three-year periods, we expect audit quality to be lower in the first two three-year periods compared to the third (i.e. the last) term. Assuming that a better audit quality is associated with a higher level of accounting conservatism, and using abnormal working capital accruals (AWCA) as a proxy for the latter, we find that the auditor becomes more conservative in the last three-year period, i.e. the one preceding the mandatory rotation. These results are confirmed using Basu’s (1997) timely loss recognition model. In an additional analysis, we use earnings response coefficients as a proxy for investor perception of audit quality, and we observe results consistent with an increase in audit quality perception in the last engagement period.

Keywords: mandatory rotation, audit firm rotation, audit quality, auditor tenure, auditor conservatism

JEL Classification: M41, M42

Suggested Citation

Cameran, Mara and Prencipe, Annalisa and Trombetta, Marco, Mandatory Audit Firm Rotation and Audit Quality (April 4, 2014). European Accounting Review Forthcoming, Available at SSRN: https://ssrn.com/abstract=2420370

Mara Cameran (Contact Author)

Bocconi University - Department of Accounting ( email )

Via Roentgen 1
Milan, 20136
Italy

Annalisa Prencipe

Bocconi University - Department of Accounting ( email )

Via Roentgen 1
Milan, 20136
Italy

Marco Trombetta

IE Business School - IE University ( email )

Calle Maria de Molina 12
Madrid, Madrid 28006
Spain

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