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  • The Auditing Section
    Mandatory Audit Partner Rotation, Audit Quality, and Market...6
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan and Discussion of “Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan”
    Practical Implications:

    The adoption of mandatory partner rotation in many countries suggests that regulators believe that the benefits of rotation outweigh the costs and thus a policy of mandatory rotation enhances audit quality. The results of this study provide initial evidence of the effects of mandatory partner rotation on audit quality. Contrary to regulators’ beliefs, the findings do not support the assumption that audit partner rotation will lead to audit quality increases. One caveat to these findings is whether the findings will generalize to other countries with different regulatory and legal regimes.

    Citation:

    Chi, W., H. Huang, Y. Liao, and H. Xie. 2009. Mandatory audit partner rotation, audit quality, and market perception: Evidence from Taiwan. Contemporary Accounting Research 26 (2): 359-391. 

    Bamber, E.M., and L.S. Bamber. 2009. Discussion of “Mandatory audit partner rotation, audit quality, and market perception: Evidence from Taiwan”. Contemporary Accounting Research 26 (2): 393-402.

    Keywords:
    audit quality; audit partner rotation
    Purpose of the Study:

    The Sarbanes-Oxley Act of 2002 (SOX) reduced the period that an audit partner is allowed to serve a particular client from seven consecutive years (required by the AICPA since the 1970s) to five years. The assumption behind the mandatory rotation requirement is that rotating the audit partner will improve auditor independence and audit quality. Research on audit firm rotation in the U.S. suggests that longer audit firm tenure with a client increases audit quality.  Although, as Bamber and Bamber point out, the results of audit firm rotation may be different than audit partner rotation because the costs and benefits are quite different.  For example, in rotating audit firms, the new firm brings an entirely new audit team and a new audit methodology. In rotating an audit partner, many factors continue to be the same under the new partner (the team, the overall audit methodology, the firm’s history with the client, etc.). Due to the lack of audit partner data in the U.S., this study utilizes audit partner data from Taiwan to assess the effect of mandatory audit partner rotation on audit quality. More specifically, the authors address two primary issues:

    • The authors examine whether a sample of firms subject to mandatory rotation have higher audit quality as compared to three benchmarks: 1) a sample of firms not subject to mandatory rotation, 2) the mandatory sample in the year prior to adoption, and 3) a sample of firms with voluntary audit partner rotation.
    • The authors examine whether investors perceive higher audit quality for the firms subject to the mandatory rotation requirements relative to the three benchmark samples mentioned above.
    Design/Method/ Approach:

    The authors use data for publicly-listed firms in Taiwan from the 2004 Taiwan Economic Journal database.  Mandatory audit partner rotation became mandatory for firms listed on the two major stock exchanges in 2004.  For the 2004 firms, some companies had partners that were required to rotate off the engagement (firms subject to mandatory rotation in that year) whereas other companies did not have partners required to rotate as they had not been on the engagement long enough yet (a non-rotation sample). 

    Findings:
    • Audit quality is not significantly different when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms not subject to mandatory rotation in 2004.  They also find no significant difference in audit quality when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms whose audit partner voluntarily rotated in years before 2003.  
    • The audit quality provided by new partners for Taiwan firms subject to mandatory rotation in 2004 is lower than the audit quality of those same Taiwan firms one year earlier, when the audit was led by the prior partner.
    • The authors find that perceived audit quality is not significantly different when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of Taiwan firms not subject to mandatory rotation in 2004.  They also find no difference in perceived audit quality when comparing the sample of Taiwan firms subject to mandatory rotation in 2004 to the sample of those same Taiwan firms one year earlier.  They find that perceived audit quality is significantly higher for firms subject to mandatory rotation in 2004 compared to firms where audit partners voluntarily rotated prior to 2003. 
    Category:
    Independence & Ethics, International Matters
    Sub-category:
    Audit Firm Rotation, Audit Partner Rotation, Audit Firm Rotation
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  • Jennifer M Mueller-Phillips
    Do Audit Clients Successfully Engage in Opinion Shopping?...
    research summary posted October 12, 2016 by Jennifer M Mueller-Phillips, tagged 15.0 International Matters, 15.01 Audit Partner Identification by Name, 15.03 Audit Partner Rotation 
    Title:
    Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence
    Practical Implications:

     These findings should be of interest to policy makers in China because, among other implications, the results suggest that Chinese regulators should pay attention to the switching of audit partners before they reach tenure limit for mandatory rotation. Partner-level opinion shopping could be more difficult to detect in markets in which the identity of the engagement partner is not disclosed, and it may therefore be prevalent in those markets, such as the United States.

    Citation:

     Chen, F., A. Peng, S. Xue, Z. Yang, and F. Ye. 2016. Do Audit Clients Successfully Engage in Opinion Shopping? Partner-Level Evidence. Journal of Accounting Research 54 (1): 79-112.

    Purpose of the Study:

    Opinion shopping refers to the practice by which audit clients seek alternative auditors willing to give a clean audit opinion when the incumbent auditor is likely to issue an unclean opinion. Existing studies examine whether companies successfully engage in opinion shopping through switching audit firms using data from such countries as China, the United Kingdom, and the United States. In this study, the authors examine evidence of switching audit partners within the same firm rather than switching to another firm for clean audit opinions, which they term “partner-level opinion shopping.” Statements from the PCAOB suggest that partner-level rotation shopping has become a regulatory concern and the regulators believe that this practice may be more prevalent if the names of engagement partners are not publicly disclosed; however, there is no empirical evidence on the existence and extent of partner-level opinion shopping to the best of the authors’ knowledge. Consequently, the authors attempt to fill this gap in the auditing literature by testing whether companies successfully engage in partner-level opinion shopping.

    Design/Method/ Approach:

    The authors decided to use data from China because engagement partners in China are required to sign the audit report, which enables the authors to identify partner switches before partners reach their mandatory rotation limit. The sample consists of observations from 1998 to 2012. They use an audit reporting model to determine a company’s probability of receiving a modified audit opinion (MAO) with and without a partner switch. 

    Findings:
    • The authors find consistent results for partner-level opinion shopping for both field partner and review partner switching.
    • The authors’ findings support the notion that partner-level opinion shopping is less likely to be successful for companies audited by firms organized as partnerships.
    • The authors find no evidence suggesting that outgoing audit partners are overly conservative compared with an average audit partner with an expected conservatism score of zero; the authors do not find evidence that incoming partners are less conservative than outgoing partners.
    • The authors find evidence that Chinese companies successfully engage in partner-level opinion shopping.
    • The authors find that the extent of success in opinion shopping is affected by client importance and the organizational forms of audit firms.
    • The authors’ results show that companies that successfully engage in opinion shopping report significantly lower-quality earnings, as indicated by higher discretionary accruals and a higher likelihood of reporting small profits.
    • The authors find direct evidence that incoming audit partners, for companies that obtain more favorable audit opinions after a partner switch, have a higher propensity to issue clean opinions than outgoing partners.
    Category:
    International Matters
    Sub-category:
    Audit Partner Identification by Name, Audit Partner Rotation
  • Jennifer M Mueller-Phillips
    Benefits and Costs of Appointing Joint Audit Engagement...
    research summary posted May 31, 2016 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Benefits and Costs of Appointing Joint Audit Engagement Partners
    Practical Implications:

     The results of this study are important to understanding the potential benefits of joint engagement partner audits compared to single-partner audits. The results of this study identify an association between the type of partner audit (joint vs. single) and audit quality and audit fees. As regulators consider the association between joint audits and audit quality, the results of this study suggest there are benefits to joint-partner audits, particularly when the partners are located in the same office. Compared to single-partner audits, joint-partner audits are associated with higher audit quality. Compared to joint audit firms, joint-partner audits appear to provide the same benefits without the increased cost.

    Citation:

    Ittonen, K., and P. C. Trønnes. 2015. Benefits and costs of appointing joint audit engagement partners. Auditing: A Journal of Practice & Theory 34 (3): 23-46.

    Keywords:
    Joint auditing; engagement partners; audit quality; audit fees
    Purpose of the Study:

    Audits using joint engagement partners versus audits using a single engagement partner may produce significant benefits. The purpose of this study is to examine the relationship between joint engagement partners and audit quality and audit fees. The authors of the study predict that joint audit partners improves audit quality via benefits in knowledge and experience, consultation availability with a joint partner, and reducing client-specific knowledge lost due to partner rotation.

    Design/Method/ Approach:

    The authors use 1,345 firm-year observations from the NASDAQ OMX Exchanges in Finland and Sweden for the period 2005 to 2009.

    Findings:
    • The authors find a stronger association between joint engagement partners and higher audit quality when the partners are from the same, rather than a different, office.
    • The authors find that joint engagement partners, compared to single partners, are associated with less accruals (two proxies for audit quality).
    • The authors find a small decrease in audit fees for joint engagement partners from different offices compared to single-partner audits. The authors find no difference in audit quality. 
    Category:
    Audit Team Composition, Independence & Ethics, International Matters
    Sub-category:
    Audit Firm Rotation, Audit Partner Rotation, Partner Rotation
  • Jennifer M Mueller-Phillips
    Audit Partner Tenure and Audit Planning and Pricing.
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Audit Partner Tenure and Audit Planning and Pricing.
    Practical Implications:

    This study provides the first evidence using U.S. data on the relationships between audit planning and pricing and audit partner tenure. Importantly, the results speak to the requirement in SOX Section 203 that audit partners on public clients rotate every five years. The second set of results concerns changes in auditor risk responsiveness during the period 2002 to 2003. Because there are very few longitudinal studies of engagement effort that feature a consistent sample of clients over time, this study contributes to understanding of changes in audit firms’ risk responsiveness.

    Citation:

    Bedard, J. C., and K. M. Johnstone. 2010. Audit Partner Tenure and Audit Planning and Pricing. Auditing: A Journal of Practice & Theory 29 (2): 45-70.

    Keywords:
    audit effort, audit partner tenure, audit pricing, risk management, rotation
    Purpose of the Study:

    This paper investigates the association between audit engagement partner tenure and audit planning and pricing. Limitations on partner tenure for public company engagements exist in many developed countries. For instance, in the U.S., the AICPA’s SEC Practice Section has long had a professional requirement that audit partners of public clients be rotated at least once every seven years. Section 203 of the Sarbanes-Oxley Act (SOX) codifies a partner tenure limitation for public companies into law, and reduces the period to five years. Proponents of frequent partner rotation argue that the auditor’s independence and objectivity suffer from long tenure with the client, which may result in lower audit quality, and that the fresh perspective of a new partner is thereby beneficial. However, many in the auditing profession maintain that mandatory partner rotation causes unnecessary costs, and may in fact impair audit quality. This position is derived from concerns that while client information is stored in the workpapers, each new engagement partner faces a certain amount of information asymmetry due to less history of client interaction.

    Design/Method/ Approach:

    The data includes client characteristics and plans for audit engagements of publicly traded companies to be conducted during 2002 and 2003, gathered by the participating audit firm in support of its client continuance decisions. The final sample size is well over 500. The models consider 20022003 risk assessments and audit planning/pricing decisions for the firm’s continuing public clients in 2002, i.e., those that the firm audited in 2001 and prior years.

    Findings:
    • The level of planned effort does not differ for clients having longer versus shorter tenure partners.
    • Engagements with longer partner tenure have significantly higher realization rates, suggesting that client demand for services of those partners and associated reduction in fee pressure enables a greater return on their engagements.
    • Results reveal that relative to the prior year engagement of the client, audit effort increases in the year of the partner change.
    • Planned realization rates decline in the year of the partner rotation.
    • In combination, the results suggest that tightening the term of mandatory partner rotation from seven to five years removes a service valued by clients.
    • Levels of risks related to financial reporting quality, management integrity, and internal controls are positively associated with the levels of planned effort in 2002.
    • Changes in assessments of financial reporting risk, management integrity risk and internal control risk are positively associated with changes in planned effort from 2002 to 2003.
    • Overall, the authors conclude that from 2002–2003, the firm’s risk response was strong in 2002, and further increased in 2003. This change was more predominant in effort rather than unit pricing, which has positive implications for audit quality.
    Category:
    Engagement Management, International Matters
    Sub-category:
    Audit Fees & Fee Negotiations, Audit Partner Rotation
  • Jennifer M Mueller-Phillips
    Does Mandatory Rotation of Audit Partners Improve Audit...
    research summary posted July 16, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 15.0 International Matters, 15.01 Audit Partner Identification by Name, 15.03 Audit Partner Rotation 
    Title:
    Does Mandatory Rotation of Audit Partners Improve Audit Quality?
    Practical Implications:

    The authors contribute to the literature on mandatory partner rotation by showing that it has a beneficial impact on audit quality even in the absence of mandatory audit firm rotation. The findings are important given that many countries currently require partner rotation, but not audit firm rotation. The authors infer how mandatory rotation affects audit quality by examining the impact on audit adjustments. The authors contribute to the existing literature on the determinants of audit adjustments by showing that mandatory partner rotation increases the frequency of adjustments during the partner’s final year of tenure and during the replacement partner’s first year of tenure.

    Citation:

     Lennox, C. S., Wu, X., & Zhang, T. 2014. Does Mandatory Rotation of Audit Partners Improve Audit Quality? Accounting Review 89 (5): 1775-1803.

    Keywords:
    audit adjustment, audit partners, audit quality, mandatory rotation
    Purpose of the Study:

    Many jurisdictions impose limitations on the length of audit partner tenure, but they impose no limitations on the length of audit firm tenure. Despite the widespread prevalence of this practice, there is very little evidence on the consequences of mandatory partner rotation when audit firms do not have to be rotated. This is primarily because most countries do not require partners’ names to be disclosed and so researchers are unable to identify when partner rotation occurs.

    When only the audit partner is rotated and the audit firm remains the same, the audit methodology, procedures, and other engagement personnel do not necessarily change. Therefore, it is an open question whether mandatory partner rotation can really improve audit quality. This question is important because if mandatory partner rotation does not help to improve audit quality, then regulators are likely to call for alternative and more restrictive policies, such as mandatory rotation of the entire audit firm.

    The authors choose China as the empirical setting for two reasons. First, just as in the U.S., in China, the engagement and review partners have to be rotated every five years. Audit reports in China disclose the names of both partners. This allows the authors to identify cases in which one or both of the partners are switched due to the mandatory rotation requirements. Second, since 2006, audit firms in China must report the pre-audit annual profits of all publicly traded clients to the Ministry of Finance. The Ministry provided these proprietary data to the authors for the purposes of academic research.

    Design/Method/ Approach:

    The authors use a logistic model to test their hypotheses. The authors use a final sample of 6,341 company-year observations from the Inspection Bureau’s audit adjustments database for the period 20062010. All the partner rotations in the sample occur on audit firms’ continuing engagements.

    Findings:

    1) Audit adjustments occur more often when the engagement partner is scheduled for mandatory rotation at the end of the year. Consistent with a beneficial peer review effect, this suggests that the departing partner anticipates the arrival of a new partner in year t+1 and this motivates the departing partner to conduct a higher quality audit in year t.

    2) Audit adjustments occur more often during the incoming partner’s first year of tenure than in other years. This is consistent with mandatory rotation generating a fresh perspective, such that a newly appointed partner is more likely to detect and correct financial reporting problems during the first year of tenure.

    Overall, the results suggest that mandatory partner rotation has a beneficial effect in the partner’s final year of tenure before rotation occurs and in the subsequent year when the new partner is appointed. The results are found to be statistically significant for: (1) large and small adjustments, and (2) downward and upward adjustments. The results are statistically significant for engagement partners, but not for review partners, which makes sense given that the engagement partner has a more important role in the audit fieldwork.

    Category:
    Audit Quality & Quality Control, International Matters
    Sub-category:
    Audit Partner Identification by Name, Audit Partner Rotation
  • The Auditing Section
    Audit Partner Tenure and Audit Quality
    research summary posted May 7, 2012 by The Auditing Section, tagged 04.0 Independence and Ethics, 04.07 Audit Firm Rotation, 05.0 Audit Team Composition, 05.03 Partner Rotation, 15.0 International Matters, 15.03 Audit Partner Rotation 
    Title:
    Audit Partner Tenure and Audit Quality
    Practical Implications:

    The results of this study are limited to the debate concerning individual audit partner rotation and do not support the argument for, or negate the prior studies that examine, audit firm rotation.  Combining the results of this study with the prior studies suggests that audit firms develop, over time, client and industry-specific knowledge that increases their ability to provide quality audits, and if quality control procedures within the firm are adequate (such as might be expected at a Big 6 firm), then rotating audit partners periodically helps maintain the auditor’s independence and objectivity while minimizing the loss of client-specific knowledge and rtise.

    Citation:

    Carey, P. and R. Simnett 2006. Audit Partner Tenure and Audit Quality. The Accounting Review 81 (3): 653-676.

    Keywords:
    audit partner tenure; audit quality; qualifications; earnings management
    Purpose of the Study:

    For many years, regulators have expressed concern regarding auditors’ extended associations with particular audit clients (i.e., long auditor tenure) and its potential impact on auditors’ independence and objectivity.  In the U.S., the AICPA Practice Section mandated in the 1970’s that audit partners rotate off their client after a seven year period.  The Sarbanes-Oxley Act of 2002 decreased this period to five years for public company engagements.  Outside the U.S., countries following international accounting standards and the Code of Ethics implemented by the International Federation of Accountants, as well as the United Kingdom and Australia, adopted similar standards by the early 2000’s due to the perceived “familiarity threat” associated with long auditor tenure.  Two of the arguments for mandatory rotation are that long auditor tenure 1) results in personal relationships with the client that could impair, consciously or subconsciously, the auditor’s independence, and 2) weakens the auditor’s ability to critically evaluate the client’s assertions.  However, to date, there is little empirical evidence to support these
    arguments.

    Due to data limitations, previous studies examining auditor tenure tend to focus on tenure of the audit firm as a whole.  Contrary to regulators’ perceptions, those studies tend to find that audit quality actually deteriorates in the early years after a change in the client’s audit firm, which is attributed to the “learning curve” effect, and that higher audit quality is associated with longer audit firm tenure, which is consistent with the audit firm developing more knowledge and familiarity with the client and industry as time progresses.  Based on their actions, regulators appear convinced that the potential benefits associated with auditor rotation are greater than the potential risks.  Therefore, the purpose of this study is to further examine whether long auditor tenure contributes to decreased audit quality in a setting where individual audit partners can be identified for particular audit clients.

    Design/Method/ Approach:

    The authors rely on data for Australian-domiciled companies publicly traded on the Australian Stock Exchange in 1995.  The authors accumulate auditor tenure information through 1997.

    The authors proxy for audit quality using three different measures: 1) the auditor’s propensity to issue a going-concern opinion; 2) the client’s reporting of abnormal working capital accruals; and 3) the extent to which key earnings targets are just beaten or missed.  Using the results of prior studies and the arguments and policies provided by regulators, the authors examine the association between audit quality and three measures of auditor tenure: less than two years, three to seven years, and greater than seven years.

    Findings:
    • For going-concern opinions, the authors find that longer audit partner tenures do decrease the individual auditors’ propensity to issue such an opinion.  Sensitivity analyses for this test suggest that these results are driven by non-Big 6 audit firm partners.
    • The results of this study find no association between abnormal working capital accruals and longer audit partner tenure. 
      These findings are in contrast to a prior study that examines the Taiwanese market and does find some support for an increased association between abnormal accruals (i.e., lower earnings quality) and longer auditor tenures,
    • The results show limited evidence of fewer clients just missing earnings benchmarks (i.e., more clients beating earnings benchmarks) in cases where the audit partner has longer tenure at the client.
    Category:
    Independence & Ethics, Audit Team Composition, International Matters
    Sub-category:
    Audit Firm Rotation, Partner Rotation, Audit Partner Rotation, Audit Firm Rotation
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