Selective Auditor Rotation and Earnings Management: Evidence from Korea

48 Pages Posted: 4 Jul 2004

See all articles by Jeong-Bon Kim

Jeong-Bon Kim

Simon Fraser University; City University of Hong Kong

Chung-ki Min

Hankuk University of Foreign Studies - Department of Economics

Cheong H. Yi

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: June 2004

Abstract

In Korea, the regulatory authority designates external auditors for firms that are deemed to have high incentives and/or great potential for opportunistic earnings management, and mandates these firms to replace their incumbent auditors by new designated auditors and requires them to keep the designated auditor for a period of typically one to three years. We call this regulatory regime selective auditor rotation. This paper investigates whether the selective auditor rotation rule in Korea is effective in deterring income-increasing earnings management. Consistent with our hypothesis, we find that the level of discretionary accruals is significantly lower for firms with designated auditors than firms that freely select their auditors. We also find that the level of discretionary accruals is significantly lower during the designation period, compared to the level during a year prior to the imposed rotation. The above findings are robust to a battery of robustness checks. Overall, our results are consistent with the notion that the selective auditor rotation enhances audit quality and thus the credibility of financial reporting.

Keywords: Selective Auditor Rotation, Audit Quality, Earnings management

JEL Classification: G38, L15, L84, G34, M41, M43, M49

Suggested Citation

Kim, Jeong-Bon and Min, Chung-ki and Yi, Cheong H., Selective Auditor Rotation and Earnings Management: Evidence from Korea (June 2004). Available at SSRN: https://ssrn.com/abstract=560522 or http://dx.doi.org/10.2139/ssrn.560522

Jeong-Bon Kim (Contact Author)

Simon Fraser University ( email )

8888 University Drive
Burnaby, British Colombia V5A 1S6
Canada

City University of Hong Kong ( email )

Department of Accountancy
83 Tat Chee Avenue
Kowloon Tong
Hong Kong
852-3442-7909 (Phone)

Chung-ki Min

Hankuk University of Foreign Studies - Department of Economics ( email )

270 Imun-dong Dongdaemun-gu
Seoul, 130-791
Korea
+822 404 9927 (Phone)
+822 968 3295 (Fax)

Cheong H. Yi

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon, Kowloon
Hong Kong
852-2766-7083 (Phone)
852-2330-9845 (Fax)