IDEAS home Printed from https://ideas.repec.org/a/kap/ejlwec/v40y2015i2p225-246.html
   My bibliography  Save this article

The link between in- and external rotation of the auditor and the quality of financial accounting and external audit

Author

Listed:
  • Patrick Velte
  • Carl-Christian Freidank

Abstract

The European Commission (EC) regulation draft of 2011 contains the external mandatory auditor rotation (audit firm rotation) as a reform measure to increase auditor independence. The external auditor firm rotation could supplement the internal mandatory rotation (auditor rotation) by the 8th EC directive. This article presents an agency theoretical foundation of rotation. In this context, the main influences on low balling and on the expectation gap will be presented. The total effect of the rotation on financial accounting and audit quality is theoretically uncertain, because the rotation can also lead to a decreased independence in a low balling situation and is connected with interrupted or lost learning and knowledge effects by the auditor or the audit firm. Then, a state of the art analysis of empirical research results with regard to auditor and audit firm rotation is focused. In contrast to the assumption of the EC, the majority of the empirical results don’t lead to an increased financial accounting and audit quality by audit firm rotations. Furthermore, the positive effects of the internal rotation period of 7 years and the cooling off period of 2 years by the 8th EC directive are not empirically proved yet. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • 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.
    • Handle: RePEc:kap:ejlwec:v:40:y:2015:i:2:p:225-246
    DOI: 10.1007/s10657-012-9361-0
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s10657-012-9361-0
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1007/s10657-012-9361-0?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Ali Abedalqader Al-Thuneibat & Ream Tawfiq Ibrahim Al Issa & Rana Ahmad Ata Baker, 2011. "Do audit tenure and firm size contribute to audit quality?: Empirical evidence from Jordan," Managerial Auditing Journal, Emerald Group Publishing, vol. 26(4), pages 317-334, April.
    2. Sattar A. Mansi & William F. Maxwell & Darius P. Miller, 2004. "Does Auditor Quality and Tenure Matter to Investors? Evidence from the Bond Market," Journal of Accounting Research, Wiley Blackwell, vol. 42(4), pages 755-793, September.
    3. 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.
    4. Reiner Quick, 2012. "EC Green Paper Proposals and Audit Quality," Accounting in Europe, Taylor & Francis Journals, vol. 9(1), pages 17-38, June.
    5. Jones, Jj, 1991. "Earnings Management During Import Relief Investigations," Journal of Accounting Research, Wiley Blackwell, vol. 29(2), pages 193-228.
    6. Ettredge, M & Greenberg, R, 1990. "Determinants Of Fee Cutting On Initial Audit Engagements," Journal of Accounting Research, Wiley Blackwell, vol. 28(1), pages 198-210.
    7. Antle, R, 1982. "The Auditor As An Economic Agent," Journal of Accounting Research, Wiley Blackwell, vol. 20(2), pages 503-527.
    8. Quick, Reiner, 2012. "EC Green Paper Proposals and Audit Quality," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 60560, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    9. Arrunada, Benito & Paz-Ares, Candido, 1997. "Mandatory rotation of company auditors: A critical examination," International Review of Law and Economics, Elsevier, vol. 17(1), pages 31-61, March.
    10. Watts, Ross L & Zimmerman, Jerold L, 1983. "Agency Problems, Auditing, and the Theory of the Firm: Some Evidence," Journal of Law and Economics, University of Chicago Press, vol. 26(3), pages 613-633, October.
    11. DeAngelo, Linda Elizabeth, 1981. "Auditor size and audit quality," Journal of Accounting and Economics, Elsevier, vol. 3(3), pages 183-199, December.
    12. Neil Fargher & Ho-Young Lee & Vivek Mande, 2008. "The effect of audit partner tenure on client managers' accounting discretion," Managerial Auditing Journal, Emerald Group Publishing, vol. 23(2), pages 161-186, January.
    13. Patrick Velte, 2012. "External rotation of the auditor," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 23(1), pages 81-91, September.
    14. Sandra K. Gates, 2007. "Restoring public confidence in capital markets through auditor rotation," Managerial Auditing Journal, Emerald Group Publishing, vol. 22(1), pages 5-17, February.
    15. Andrew B. Jackson & Michael Moldrich & Peter Roebuck, 2008. "Mandatory audit firm rotation and audit quality," Managerial Auditing Journal, Emerald Group Publishing, vol. 23(5), pages 420-437, May.
    16. Larry R. Davis & Billy S. Soo & Gregory M. Trompeter, 2009. "Auditor Tenure and the Ability to Meet or Beat Earnings Forecasts," Contemporary Accounting Research, John Wiley & Sons, vol. 26(2), pages 517-548, June.
    17. DeAngelo, Linda Elizabeth, 1981. "Auditor independence, `low balling', and disclosure regulation," Journal of Accounting and Economics, Elsevier, vol. 3(2), pages 113-127, August.
    18. Michael Spence, 1973. "Job Market Signaling," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 87(3), pages 355-374.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Donato Masciandaro, 2016. "Banking Supervision Outsourcing: Economics, Rules and Drivers," BAFFI CAREFIN Working Papers 1616, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    2. Ioan-Bogdan ROBU & Maria GROSU & Costel ISTRATE, 2016. "The Effect of the Auditors’ Rotation on the Accounting Quality in the Case of Romanian Listed Companies under the Transition to IFRS," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 14(133), pages 1-65, January.
    3. Beatriz García Osma & Ana Gisbert & Elena Heras Cristóbal, 2017. "Public oversight systems for statutory auditors in the European Union," European Journal of Law and Economics, Springer, vol. 44(3), pages 517-552, December.
    4. Reshma Kumari Tiwari & Jasojit Debnath, 2021. "Joint Provision of Non-audit Services to Audit Clients: Empirical Evidences from India," Vikalpa: The Journal for Decision Makers, , vol. 46(3), pages 153-165, September.
    5. Donato Masciandaro & Davide Romelli, 2017. "Banking Supervision and External Autditors: What works best?," BAFFI CAREFIN Working Papers 1746, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    6. Michal Šindelář, 2016. "Rotation of auditors of companies listed on the stock market of the Prague Stock Exchange [Rotace auditorů společností kótovaných na akciovém trhu Burzy cenných papírů Praha]," Český finanční a účetní časopis, Prague University of Economics and Business, vol. 2016(3), pages 59-71.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Patrick Velte, 2012. "External rotation of the auditor," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 23(1), pages 81-91, September.
    2. 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.
    3. Corbella, Silvano & Florio, Cristina & Gotti, Giorgio & Mastrolia, Stacy A., 2015. "Audit firm rotation, audit fees and audit quality: The experience of Italian public companies," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 25(C), pages 46-66.
    4. DeFond, Mark & Zhang, Jieying, 2014. "A review of archival auditing research," Journal of Accounting and Economics, Elsevier, vol. 58(2), pages 275-326.
    5. Christopher Bleibtreu & Stephan Ulrike Stefani, 2013. "The Effects of Mandatory Auditor Rotation on Low Balling Behavior and Auditor Independence," Working Paper Series of the Department of Economics, University of Konstanz 2013-14, Department of Economics, University of Konstanz.
    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. 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.
    8. Knechel, W. Robert & Thomas, Edward & Driskill, Matthew, 2020. "Understanding financial auditing from a service perspective," Accounting, Organizations and Society, Elsevier, vol. 81(C).
    9. Persefoni Polychronidou & George Drogalas & Ioannis Tampakoudis, 2020. "Mandatory rotation of audit firms and auditors in Greece," International Journal of Disclosure and Governance, Palgrave Macmillan, vol. 17(2), pages 141-154, September.
    10. Chung, Richard & Firth, Michael & Kim, Jeong-Bon, 2005. "Earnings management, surplus free cash flow, and external monitoring," Journal of Business Research, Elsevier, vol. 58(6), pages 766-776, June.
    11. 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.
    12. 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).
    13. Juan Monterrey Mayoral & Amparo Sánchez-Segura, 2007. "Rotación y dependencia económica de los auditores: sus efectos sobre la calidad del resultado en las compañías cotizadas españolas," Investigaciones Economicas, Fundación SEPI, vol. 31(1), pages 119-159, January.
    14. Patrick Velte & Stefan Weber, 2010. "Koalitionsbildungen im Rahmen der Corporate Governance als Anlass für weitere Reformen des unternehmerischen Überwachungssystems," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 20(4), pages 393-417, March.
    15. Gholamreza Rahimi & Samira Mohammad Amini, 2015. "The Survey of the Relationship between Auditing Quality and the Profitability in the Companies Accepted in Tehran’s Exchange Market," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 5(2), pages 100-115, April.
    16. Gary S. Monroe & NG Juliana & Andrew J. Wellington, 1992. "Limiting Auditors‘ Liability: The Potential Consequences," Australian Accounting Review, CPA Australia, vol. 1(4), pages 16-26, November.
    17. Sterling Huang & Gilles Hilary, 2018. "Zombie Board: Board Tenure and Firm Performance," Journal of Accounting Research, Wiley Blackwell, vol. 56(4), pages 1285-1329, September.
    18. Habib, Ahsan, 2011. "Audit firm industry specialization and audit outcomes: Insights from academic literature," Research in Accounting Regulation, Elsevier, vol. 23(2), pages 114-129.
    19. Alzoubi, Ebraheem Saleem Salem, 2018. "Audit quality, debt financing, and earnings management: Evidence from Jordan," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 30(C), pages 69-84.
    20. Adam Esplin & Karim Jamal & Shyam Sunder, 2018. "Demand for and Assessment of Audit Quality in Private Companies," Abacus, Accounting Foundation, University of Sydney, vol. 54(3), pages 319-352, September.

    More about this item

    Keywords

    Low balling; Expectation gap; Audit quality; Empirical audit research; Accounting policy; Auditor independence; M4; H1; K2; G3;
    All these keywords.

    JEL classification:

    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • H1 - Public Economics - - Structure and Scope of Government
    • K2 - Law and Economics - - Regulation and Business Law
    • G3 - Financial Economics - - Corporate Finance and Governance

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:ejlwec:v:40:y:2015:i:2:p:225-246. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sonal Shukla or Springer Nature Abstracting and Indexing (email available below). General contact details of provider: http://www.springer.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.