Costs and benefits of mandatory audit firm rotation: initial engagement experience of audit committee chairs and engagement partners

ABSTRACT

Audit regulators remain divided on whether the costs of mandatory audit firm rotation (MAFR) will be outweighed by the benefits of the regulation. Existing research provides mixed results in support of the benefits of MAFR. This paper aims to complement these studies by examining what costs and benefits are experienced during the initial engagement after a MAFR. Interviews were conducted with dyads of South African audit committee chairs and audit partners involved in the same appointment process and initial audit engagement following a MAFR. While many audit committee chairs remained opposed to MAFR, most were impressed by the better-than-expected benefits of the fresh perspective and challenge offered by a newly appointed audit firm, and the less than expected costs of losing the incumbent auditor’s knowledge. By comparison, most audit partners expressed support for MAFR after their experience with the regulation and believed the policy would improve public perceptions of independence but raised concerns about the significant start-up costs their firms had been forced to absorb. As a result, while the findings suggest that the primary arguments against MAFR may be overstated, there is a risk that MAFR may compromise auditor independence by pressurising auditors to appease their new clients to retain the engagement and recover these initial costs. This paper provides insights for policymakers considering the costs and benefits of implementing MAFR, and for audit committees and auditors who seek to maximise the benefits while minimising the costs of their next MAFR event.

KEYWORDS:

• Mandatory audit firm rotation
• auditor independence
• audit quality
• corporate governance

Data availability

Individual audit committee chair and audit partner responses are confidential.

Acknowledgement

The authors would like to thank participants at the various workshops, conferences and informal gatherings of Meditari Accountancy Research and the Centre for Critical Accounting and Auditing Research. We would like to acknowledge the helpful feedback from our anonymous reviewers, Wayne van Zijl, Linda De Beer, Danielle Cerbone and Dusan Ecim. Finally, we are grateful to Lelys Maddock for providing a “non-accountant's perspective” and proofreading this paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 While “independence in appearance” relates to the public perception of a lack of bias, “independence in mind” refers to the reality of the auditors’ state of mind i.e. whether the auditor is independent “in fact” (see the International Code of Ethics for Professional Accountants IESBA, 2018, section 290).

2 Again, these opinions are collected from practitioners who were not operating within a MAFR setting and thus, in contrast with our paper, represent views that are not informed by real and recent experiences of forced rotations.

3 Low-balling is the practice of strategic fee discounting to secure appointment. The practice is considered unethical if the fee quoted is so low that it prejudices the ability of the auditor to perform the engagement in accordance with applicable technical and professional standards (IESBA, 2018).

4 Approximately USD0.7 million USD7 billion.

5 All auditors interviewed had prior experience with proposing appointments to secure new clients, as well as with partner rotations within existing clients. AC chairs also possessed prior experiences with oversight of AP rotations. These experiences served as a base from which to contrast the recent novel experience of audit firm rotation.

6 For example, the AC chair was asked about their discussions with the CFO of the company concerning the challenges of running the business while the audit was being performed. The AP was asked how co-operative the CFO was in aiding the audit team in their requests. Again, the AP was questioned concerning challenges experienced in delivering the audit on budget and the areas requiring audit emphasis, whereas the AC chair was asked about the impact of the audit on the business and audit committee responsibilities.

7 While face-to-face interviews are widely viewed as the “gold-standard” (Tucker & Parker, 2014), the geographical dispersion and availability of the participants meant telephonic interviews was the best approach to gain access to such high-profile interviewees.

8 Table 1 shows how all company, AC chair and AP names have been replaced with identifiers (Company 01; AC01; AP01 etc.) for the purpose of providing quotes.

9 While excluded from our analysis, three of the AC chairs from the four companies from which we were unable to obtain an interview with the AP also changed opinions in favour of MAFR for similar reasons to those outlined in the remainder of this study.