Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan

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Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan*
WUCHUN CHI, National Chengchi University HUICHI HUANG, Syracuse University YICHUN LIAO, National Taiwan University HONG XIE, University of Kentucky 1. Introduction Mandatory audit partner rotation has existed in the United States since the 1970s, when the American Institute of Certified Public Accountants (AICPA) required that audit partners in charge of Securities and Exchange Commission (SEC) audits be rotated at least once every seven years. The Sarbanes-Oxley Act of 2002 (SOX) further strengthens this requirement by mandating a five-year rotation for the lead and concurring partners. An implicit assumption in a policy of mandatory partner…show more content…
We find no difference in audit quality between these two samples. Second, we compare the mandatory rotation sample with itself one year earlier (2003) (the mandatory rotation sample in the prior year). We find that the audit quality of companies in the mandatory rotation sample under new audit partners is lower than the audit quality of these same companies one year earlier under old audit partners. Third, we compare our mandatory rotation sample with companies in years before 2003 whose audit partners were voluntarily rotated within the same audit firm (the voluntary rotation sample). We again find no difference in audit quality between these two samples. In sum, we find no support for the belief that mandatory audit partner rotation enhances audit quality. Our findings are robust to various sensitivity checks. Next, we examine the effect of mandatory audit partner rotation on investor perceptions of audit quality, using the earnings response coefficient (ERC) as a proxy for perceived audit quality (Teoh and Wong 1993; Ghosh and Moon 2005), After controlling for common determinants of the ERC, we find that the ERC of the mandatory rotation sample is not significantly different from that of the nonrotation sample or that of the mandatory rotation sample in the prior year, but is significantly larger than the ERC of the voluntary rotation sample. Overall, we find no consistent support for the belief that mandatory
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