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An Experimental Investigation of Retention and Rotation Requirements

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  • Nicholas Dopuch
  • Ronald R. King
  • Rachel Schwartz

Abstract

We provide results from an experiment designed to assess whether mandatory rotation and/or retention of auditors increases auditors' independence by reducing their willingness to issue reports biased in favor of management. Auditors' reporting is compared across the following four regimes: one that does not require either rotation or retention, a second that requires retention only, a third that requires rotation only, and a fourth that requires both rotation and retention. We find that the rotation requirements in the third and fourth regimes decreased auditor‐subjects' willingness to issue biased reports, relative to the two regimes in which rotation was not imposed. In these other two regimes, however, many manager‐subjects voluntarily retained the same auditor‐subjects over multi‐periods. While the long running interactions between manager‐ and auditor‐subjects resulted in more favorable reports by auditor‐subjects (a lower level of independence), the established relationships also induced manager‐subjects to make higher investments.

Suggested Citation

  • Nicholas Dopuch & Ronald R. King & Rachel Schwartz, 2001. "An Experimental Investigation of Retention and Rotation Requirements," Journal of Accounting Research, Wiley Blackwell, vol. 39(1), pages 93-117, June.
    • Handle: RePEc:bla:joares:v:39:y:2001:i:1:p:93-117
    DOI: 10.1111/1475-679X.00005
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    Cited by:

    1. Zhang, Xuehua & Yan, Huanmin & Hu, Fang & Wang, Hongjian & Li, Xiaoning, 2022. "Effect of auditor rotation violation on audit opinions and audit fees: Evidence from China," Research in International Business and Finance, Elsevier, vol. 62(C).
    2. Mark Schelker, 2012. "The influence of auditor term length and term limits on US state general obligation bond ratings," Public Choice, Springer, vol. 150(1), pages 27-49, January.
    3. Wang, Karl J. & Tuttle, Brad M., 2009. "The impact of auditor rotation on auditor-client negotiation," Accounting, Organizations and Society, Elsevier, vol. 34(2), pages 222-243, February.
    4. Gómez Aguilar, Nieves & Biedma López, Estíbaliz & Ruiz Barbadillo, Emiliano, 2018. "El efecto de la rotación de socio en la calidad de la auditoría," Revista de Contabilidad - Spanish Accounting Review, Elsevier, vol. 21(1), pages 7-18.
    5. Chen, Lihong & Xiao, Tingting & Zhou, Jia, 2023. "Do auditor changes affect the disclosure of critical audit matters? Evidence from China," Economic Modelling, Elsevier, vol. 122(C).
    6. Boon Seng Tan & Yew Kee Ho, 2016. "Some Economics of Audit Market Reform," Australian Accounting Review, CPA Australia, vol. 26(3), pages 271-283, September.
    7. Sook Min Kim & Seon Mi Kim & Dong Heun Lee & Seung Weon Yoo, 2019. "How Investors Perceive Mandatory Audit Firm Rotation in Korea," Sustainability, MDPI, vol. 11(4), pages 1-17, February.
    8. Frederick W. Rankin, 2004. "Coordinating Effort under Team†Based and Individual Incentives: An Experimental Analysis," Contemporary Accounting Research, John Wiley & Sons, vol. 21(1), pages 191-222, March.
    9. Minfeng Yu & Yi Si & Gaoliang Tian & Lei Zhang, 2023. "Climate risk and audit fees: An international study," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(5), pages 4989-5025, December.
    10. Booker, K., 2018. "Can clients of economically dependent auditors benefit from voluntary audit firm rotation? An experiment with lenders," Research in Accounting Regulation, Elsevier, vol. 30(1), pages 63-67.
    11. Bandyopadhyay, Sati P. & Chen, Changling & Yu, Yingmin, 2014. "Mandatory audit partner rotation, audit market concentration, and audit quality: Evidence from China," Advances in accounting, Elsevier, vol. 30(1), pages 18-31.
    12. Dickhaut, John & Ledyard, Margaret & Mukherji, Arijit & Sapra, Haresh, 2003. "Information management and valuation: an experimental investigation," Games and Economic Behavior, Elsevier, vol. 44(1), pages 26-53, July.
    13. Eun Jung Cho & Ju Ryum Chung & Ho-Young Lee, 2019. "The Role of Labor Unions in Corporate Transparency: Focusing on the Role of Governance in Auditor Change Process," Sustainability, MDPI, vol. 11(9), pages 1-21, May.
    14. Athavale, Manoj & Guo, Zhaorui & Meng, Yun & Zhang, Tianshu, 2022. "Diversity of signing auditors and audit quality: Evidence from capital market in China," International Review of Economics & Finance, Elsevier, vol. 78(C), pages 554-571.
    15. Casterella, Jeffrey R. & Johnston, Derek, 2013. "Can the academic literature contribute to the debate over mandatory audit firm rotation?," Research in Accounting Regulation, Elsevier, vol. 25(1), pages 108-116.
    16. Ruth Odin & David Jerry Oziegbe, 2022. "Auditors’ Independence, Audit Tenureship, Firm Characteristics and Audit Quality: Evidence from Nigeria," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 25(84), pages 54-68, December,.
    17. Patrick Velte, 2012. "External rotation of the auditor," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 23(1), pages 81-91, September.
    18. Firth, Michael & Rui, Oliver M. & Wu, Xi, 2012. "How Do Various Forms of Auditor Rotation Affect Audit Quality? Evidence from China," The International Journal of Accounting, Elsevier, vol. 47(1), pages 109-138.
    19. Krista Fiolleau & Kris Hoang & Karim Jamal & Shyam Sunder, 2013. "How Do Regulatory Reforms to Enhance Auditor Independence Work in Practice?," Contemporary Accounting Research, John Wiley & Sons, vol. 30(3), pages 864-890, September.
    20. Quick, Reiner & Schmidt, Florian, 2018. "Do audit firm rotation, auditor retention, and joint audits matter? – An experimental investigation of bank directors' and institutional investors' perceptions," Journal of Accounting Literature, Elsevier, vol. 41(C), pages 1-21.
    21. Mark Schelker, 2009. "Auditor Terms and Term Limits in the Public Sector: Evidence from the US States," CREMA Working Paper Series 2009-19, Center for Research in Economics, Management and the Arts (CREMA).
    22. Maria Ishaque, 2021. "Managing Conflict of Interests in Professional Accounting Firms: A Research Synthesis," Journal of Business Ethics, Springer, vol. 169(3), pages 537-555, March.
    23. Ya-Fang Wang, 2020. "New Insights on Audit Quality," International Journal of Business and Economic Sciences Applied Research (IJBESAR), International Hellenic University (IHU), Kavala Campus, Greece (formerly Eastern Macedonia and Thrace Institute of Technology - EMaTTech), vol. 13(1), pages 21-28, April.
    24. Patrick Velte & Carl-Christian Freidank, 2015. "The link between in- and external rotation of the auditor and the quality of financial accounting and external audit," European Journal of Law and Economics, Springer, vol. 40(2), pages 225-246, October.
    25. Zhang, Min & Xu, Haoran & Li, Xu, 2017. "The Effect of Previous Working Relationship between Rotating Partners on Mandatory Audit Partner Rotation," The International Journal of Accounting, Elsevier, vol. 52(2), pages 101-121.

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