Do different cooling-off modes affect audit quality? A study based on the audit rotation system in China

Using a sample from China’s regime, we find that, longitudinally, whether auditors treat former clients favorably after rotation-back depends on the cooling-off modes. Relative to the year before rotation, audit quality after rotation-back is higher if the auditors use the ‘substantive’ cooling-off mode, whereas the audit quality decreases if the auditors use the ‘non-substantive’ cooling-off mode. Horizontally, audit quality in the initial year after auditor rotation-back increases with increased length of the cooling-off period. These effects vary based on the audit firm quality control system. Furthermore, our analysis reveals that auditors exhibit a greater propensity to employ ‘non-substantive’ cooling-off strategies in instances where the client – auditor relationship is more intimate, clients have fewer business risks, and audit firms/auditors contend with constrained audit resources. We further find some evidence of client – auditor collusion under ‘non-substantive’ cooling-off modes. Our findings carry implications for application of mandatory auditor rotation requirements.