Research Report Can the academic literature contribute to the debate over mandatory audit firm rotation? Jeffrey R. Casterella a,b, ⇑ , Derek Johnston a a Colorado State University, Fort Collins, CO, USA b University of Auckland, Auckland, New Zealand article info Article history: Available online 11 January 2013 Keywords: Audit firm rotation Independence Audit quality abstract Recently, the Public Company Accounting Oversight Board (PCAOB) issued a concept release soliciting public recommendations to improve auditor independence and audit quality (PCAOB, 2011). The focus of the release is on mandatory audit firm rotation (MAFR) with a request for commentaries addressing the advantages and disadvantages of MAFR. In this paper, we briefly summarize the recent literature on mandatory audit firm rotation and suggest how it can be useful to regulators as they consider the implementation of man- datory rotation. We find that the conclusions reached about the possible effectiveness of MAFR appear to depend on the type of data used (voluntary vs. mandatory auditor changes), suggesting that regulators should exercise care when drawing inferences from past audit firm rotation research. Ó 2012 Elsevier Ltd. All rights reserved. Introduction Recently, the Public Company Accounting Oversight Board (PCAOB) issued a concept release soliciting public recommendations to improve auditor independence and audit quality (PCAOB, 2011). The focus of the release is on mandatory audit firm rotation (MAFR) and the PCAOB requests commentaries addressing the advantages and dis- advantages of MAFR. 1 In March of 2012, the PCAOB con- ducted 2 days of hearings on the pros and cons of MAFR. The hearings featured several former regulators who ad- dressed the costs and benefits of MAFR. There was little con- sensus. While former Federal Reserve chairman Paul Volcker said his experience ‘‘does suggest to me the importance of requiring rotation’’ (Tysiac, 2012), former SEC chairman Breeden seemed less convinced saying that ‘‘mandatory rotation would benefit some companies and it would prob- ably harm others’’ (Chasen, 2012). Charles Bowsher, former U.S. comptroller general, suggested a limited MAFR arrange- ment that would apply to only the largest 25 or 40 publicly traded companies. Finally, former SEC chairman Harvey Pitt expressed concern that with MAFR, ‘‘the cure could turn out to be worse than the disease, depending on the amount of time people would be required to rotate off’’ (Cohn, 2012). Given the opposing views on MAFR, the purpose of this pa- per is to provide a critical summary of recent research and suggest how it might be useful to regulators as they consider the implementation of mandatory rotation in the U.S. In an extensive review of the research examining the causes and consequences of auditor switching, Stefaniak, Robertson, and Houston (2009) note that most studies look at the association of auditor tenure and various measures of audit quality. In general, they find that audit quality is 1052-0457/$ - see front matter Ó 2012 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.racreg.2012.11.004 ⇑ Corresponding author at: College of Business, 253 Rockwell Hall, Colorado State University, Fort Collins, CO 80523, USA. Tel.: +1 970 217 0947. E-mail address: Jeff.Casterella@colostate.edu (J.R. Casterella). 1 This represents the second time in 10 years that regulators at the federal level have formally considered the implementation of MAFR. In 2003, the U.S. General Accounting Office (GAO) concluded that the Securities and Exchange Commission (SEC) and the PCAOB should not consider mandating audit firm rotation until the full effects of the Sarbanes–Oxley Act of 2002 could be assessed. The GAO report also noted that, in the future, the PCAOB will likely need to ‘‘ evaluate whether further enhancements or revisions, including mandatory audit firm rota- tion, may be needed to further protect the interest and to restore investor confidence’’ (GAO, 2003, p. 5). Research in Accounting Regulation 25 (2013) 108–116 Contents lists available at SciVerse ScienceDirect Research in Accounting Regulation journal homepage: www.elsevier.com/locate/racreg higher when there is a longer auditor–client relationship, a finding that would seem to mitigate against a policy of MAFR (DeFond & Francis, 2005; Stefaniak et al., 2009). The problem with this inference is that most of these stud- ies use data from a regulatory regime in which changing auditors is voluntary (as is currently the case in the United States). As a result, it is unclear that these results would extend to a regulatory regime where audit firm rotation is mandatory. 2 In this paper we compare studies that are based on vol- untary auditor changes with those that are based on man- datory or quasi-mandatory auditor changes 3 since it appears that the PCAOB is especially interested in studies involving the latter. 4 We find that the conclusions reached about the possible effectiveness of MAFR depend on the type of data used, suggesting that policy makers exercise caution when drawing inferences from academic research. The remainder of the paper is organized as follows. In the next section, we provide a brief summary of the MAFR debate, and discuss how the academic community has re- sponded to calls for research concerning the potential ben- efits of MAFR. In Section ‘Evidence on mandatory audit firm rotation’, we briefly summarize the evidence from the academic research, with a focus on differentiating those academic studies that use voluntary changers data from those that employ mandatory rotators data. Sec- tion ‘Summary and discussion’ concludes with a discussion of the implications that these two subsets of the audit firm rotation research have on the MAFR debate. The debate and the academic response The arguments for and against mandatory audit firm rotation are well-documented. 5 Proponents of MAFR be- lieve that long-tenure auditor–client relationships increase the likelihood of audit failures. This belief is based on the assumption that a long-tenure relationship leads to an in- creased level of familiarity between the two parties that nat- urally erodes auditor independence and professional skepticism. 6 Hence, proponents believe that audit firms should be required to roll-off engagements after a fixed per- iod of time. Such a policy would prevent the existence of any long-tenure auditor–client relationships which would, they argue, decrease the number of audit failures. Conversely, opponents of MAFR point out that audit firms gain valuable knowledge about their clients over time. As a result, oppo- nents express concern that a mandatory rotation policy would result in a lack of client-specific knowledge, causing short-tenure auditor–client relationships to be more prone to audit failures. Table 1 summarizes the various types of auditor–client relationships that would exist with and without a MAFR policy. In particular, the table describes audits in terms of mandatory rotation regime (yes/no) and auditor tenure (short/medium/long). For purposes of this table, we define short-tenure relationships as those between 1 and 3 years, medium between 4 and 6 years, and long as 7 years or longer. 7 Since the U.S. does not have a MAFR requirement, auditor–client relationships in the U.S. can be either short, medium, or long (cells 3, 4 or 5). Conversely, in a regime with mandatory rotation, no long-term auditor–client rela- tionships would exist, leaving only short and medium rela- tionships (cells 1 and 2). If the United States were to adopt a rotation policy, long-tenure audits (cell 5) would be forced into short-ten- ure audits (cell 1). Proponents argue that such a shift would result in higher audit quality due to enhanced audi- tor independence. In contrast, opponents believe that audit quality would decline because the new auditor would lack experience with the client. Put simply, proponents of MAFR argue that short-tenure auditor–client relationships will result in higher quality audits, while opponents of MAFR argue that short-tenure auditor–client relationships will result in lower quality audits. The goal of research in this area is to provide evidence regarding the potential effect of mandatory rotation on the quality of audits conducted on U.S. companies. Ideally, one would compare measures of audit quality from cell 5 audits with those from cell 1 audits. Because the U.S. does not have a mandatory rotation policy in place, the neces- sary data from cell 1 audits for U.S. public companies is not available. To circumvent this data issue, most studies substitute cell 3 data for cell 1 data. Generally speaking, these studies analyze the differences in various measures of audit quality between cell 5 and cell 3, and find that the quality of cell 5 audits are, on average, significantly better than the quality of cell 3 audits. Based on that evi- dence alone, one would conclude that a mandatory rota- tion policy would have a negative effect on audit quality, resulting in a higher occurrence of audit failures. This is where the data is issue is important. By replacing cell 1 audits with cell 3 audits, these studies rely on the assumption that the characteristics of companies with auditor relationships that fall into cell 3 are similar to those that would have short-term auditor relationships in Table 1 Types of auditor–client relationships by mandatory rotation regime. Mandatory rotation regime? Short-tenure (e.g., 63 years) Medium-tenure (e.g., 4–6 years) Long-tenure (e.g., P7 years) Yes Cell 1 Cell 2 Not applicable No Cell 3 Cell 4 Cell 5 2 In fact, the PCAOB points out this limitation of the academic literature on p. 16 of its concept release. 3 We use the term ‘‘quasi-mandatory data’’ to characterize the data gathered from controlled experiments that are designed to mimic a MAFR environment. 4 Throughout the manuscript, we refer to new audits created in a MAFR regime as ‘‘rotators’’ and new audits stemming from voluntary switching decisions as ‘‘changers’’. 5 See Stefaniak et al. (2009) for a review of the advantages and disadvantages of MAFR. 6 See Previts (1998) for a review of auditor independence, its origins and the potential for auditor conflicts of interest. In addition, Kleinman, Palmon, and Anandarajan (1998) provide an extensive review of studies that investigate auditor independence. 7 Of course, the specific number of years used by the regulator to classify each relationship could be different from those that we use. Related to this point, the PCAOB asks for input regarding the ‘‘appropriate term length’’ for rotation in its concept release. J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 109 a mandatory rotation regime. Since cell 3 audits represent new auditor–client relationships that have been created voluntarily, rather than via a mandatory rotation policy, this assumption is likely invalid. For example, Walker, Le- wis, and Casterella (2001) show that companies that vol- untarily change auditors differ significantly from a random sample of companies. More specifically, their anal- ysis suggests that voluntary changers are more likely to have fraud and be financially distressed. Moreover, Carey, Geiger, and O’Connell (2008) find that companies are more apt to voluntarily change auditors following qualified audit opinions. 8 Given the ample empirical evidence that suggests that companies that voluntarily change auditors are already ‘troubled’ companies, it is not surprising that prior research finds that the quality of cell 5 audits is higher than cell 3 audits, even after attempting to control for the determinants of the decision to voluntarily change auditors. For this rea- son, Carcello and Nagy (2004) caution that it is unclear whether the empirical results obtained from studies based on voluntary changers would extend to a MAFR setting. In summary, the MAFR literature seems to rely heavily on the use of cell 3 audits (i.e., voluntary changers); never- theless, some studies exploit settings that may be more representative of a mandatory rotation regime. In the next section, we briefly summarize the findings of prior rotation research, with a focus on differentiating studies based on the type of data employed. Evidence on mandatory audit firm rotation The Appendix summarizes, in chronological order, the key findings from 24 audit firm rotation studies from the year 2001 to present. For brevity’s sake, we limit the Appendix to empirical archival and experimental research studies published in the top 25 accounting journals as determined by Glover, Prawitt, and Wood (2006). 9 For each study, the Appendix provides information on the relation examined, sample used, and primary results. DeFond and Francis (2005) and Stefaniak et al. (2009) conclude that the majority of extant research does not pro- vide evidence to support the introduction of MAFR in the U.S. as a means to enhance audit quality. One can reach a similar conclusion based on a cursory review of the Appen- dix. In 16 of the 24 studies, there is no evidence to support the introduction of mandatory rotation. On the contrary, they bolster the argument that new audits may be prob- lematic because of a learning curve effect. Most of these studies estimate regression models that associate audit tenure with various measures of audit quality using data from regimes where changing auditors is a voluntary, rather than a mandatory, action. In such settings, the inclu- sion of a variable such as auditor tenure likely introduces self-selection bias into the model. Although there are instrumental variable methods that one can use to correct for this issue, they require assumptions about the data that may be unrealistic (Larcker & Rusticus, 2010). We strongly suggest that policy makers recognize explicitly the difference between voluntary and mandatory auditor changes. To this end, in Section ‘Evidence from studies using voluntary changers data’, we briefly summa- rize the key findings from the 13 studies that rely on data from voluntary changers to answer their research ques- tions. In Section ‘Evidence from studies using mandatory rotators data’, we review the 11 studies that examine the potential benefits of audit firm rotation using mandatory rotators data. Evidence from studies using voluntary changers data Panel A of Table 2 lists the 13 research studies that investigate the potential benefits of MAFR using voluntary changers (cell 3) data. All of the studies are archival (rather than experimental), and most of these studies regress var- ious measures of audit quality on auditor tenure and a host of control variables. For example, Geiger and Raghunandan (2002) examine the association of auditor tenure with audit quality using a sample of 117 stressed companies that eventually filed for bankruptcy. After controlling for factors such as firm size and the probability of bankruptcy, they find that as auditor tenure increases, the probability of an audit failure decreases. In addition, Johnson, Khurana, and Reynolds (2002) investigate the relation between auditor tenure and two measures of financial reporting quality (the absolute value of unexpected accruals and the persistence of accruals), and find that companies in short-term relationships (defined as 2–3 years) with their auditors have lower quality financial reports relative to companies that have been with their auditor for 4–8 years. Similarly, Myers, Myers, and Omer (2003) document a neg- ative association between auditor tenure and the absolute value of discretionary accruals using a sample of U.S. com- panies, a finding that was later confirmed by Chen, Lin, and Lin (2008) based on a sample of Taiwanese companies. Fi- nally, prior research using voluntary changers data finds that auditor tenure is: (a) negatively related to fraudulent financial reporting and firm risk (Carcello & Nagy, 2004; Crabtree, Brandon, & Maher, 2006; Mansi, Maxwell, & Mill- er, 2004); and (b) positively associated with investors’ per- ceptions of earnings quality and conservative financial reporting (Ghosh & Moon, 2005; Jenkins & Velury, 2008). Of the 13 studies that use voluntary changers data, only Li (2010) and Chi, Ling Lei, and Mikhail (2011) provide modest support for a move to MAFR. Specifically, using Big N audits over the period 1980–2004, Li (2010) finds that the reporting of conservative earnings is adversely af- fected by long-tenure audits of small companies and weekly monitored companies. Moreover, Chi et al. (2011) examine, among other things, the association of auditor tenure with earnings management, and find conflicting re- sults. Although they find that auditor tenure is negatively related to accrual earnings management, they document a positive association between auditor tenure and real earnings management. The latter result provides some support for mandatory audit firm rotation. 8 See Stefaniak et al. (2009) for a detailed discussion of the studies that explore the determinants of firms’ decisions to change audit firms. 9 In addition we include published work from two journals dedicated to auditing and/or the regulation of auditing and accounting: Research in Accounting Regulation and International Journal of Auditing. We also include two recent working papers that specifically focus on MAFR. 110 J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 Interestingly, of the 13 papers summarized in Panel A, only Li (2010) appears to take steps to explicitly control for the potential self-selection bias that may arise through the use of voluntary changers data. Specifically, Li (2010, p. 239) points out that he ‘‘ controls for an endogeneity problem possibly arising from the auditor tenure variable which is often ignored in previous studies.’’ 10 The PCAOB has voiced concern about studies that rely on samples of companies that have voluntarily changed auditors, perhaps because of the thorny econometric issues that can arise when using such data. With this in mind, we next discuss prior research that exploits settings that are more consistent with a regime of mandatory rotation. Evidence from studies using mandatory rotators data Panel B of Table 2 lists the 11 studies that use manda- tory rotators data (cell 1). Of the 11 studies listed, eight provide support for MAFR. As Panel B indicates, five of the studies use archival data, while six use experimental data. We discuss the archival studies first, and then turn our attention to the experimental studies. The demise of Arthur Andersen (AA) created a unique setting to study the effects of audit firm rotation. Although not a perfect analogy to short-term audits that would be obtained in a MAFR regime (i.e., cell 1 audits), we believe that the use of former AA clients is likely more representa- tive of mandatory rotators than are voluntary changers. Three of the five archival studies listed in Panel B use the AA setting to investigate the effect of rotation on audit quality, and provide mixed results. In particular, Blouin, Grein, and Rountree (2007) focus on former AA clients that had extreme discretionary accruals while with AA. Among other things, they find that moving to a new audit firm did not significantly curtail extreme income-increasing or in- come-decreasing discretionary accruals. In contrast, the two other studies that use AA data provide evidence that lends some support to MAFR. For example, Nagy (2005) finds a significant increase in the audit quality of smaller AA clients that were forced to find new auditors. Also, Kea- ley, Lee, and Stein (2007) documents a positive association between the number of years that clients were with AA and the audit fee charged by the new auditor. This result suggests that audit firms perceive a new client coming from a long-term relationship with its previous auditor to be riskier than one coming from a short-term relation- ship with its predecessor auditor. The remaining two archival studies use true mandatory audit firm rotation data, and once again, provide mixed re- sults. Lowensohn, Reck, Casterella, and Lewis (2011) exam- ine the Florida government audit environment in which there exists: (a) both rotation and non-rotation regimes; and (b) an independent measure of the joint quality of the audit and of the financial statements of the reporting entity. They find that, after controlling for other factors Table 2 Mandatory audit firm rotation studies partitioned by setting. Authors and publication date Method U.S. or international data? Support for MAFR? Panel A: Studies using voluntary changers (cell 3) data Geiger and Raghunandan (2002) Archival U.S. No Johnson et al. (2002) Archival U.S. No Myers et al. (2003) Archival U.S. No Mansi et al. (2004) Archival U.S. No Carcello and Nagy (2004) Archival U.S. No Ghosh and Moon (2005) Archival U.S. No Crabtree et al. (2006) Archival U.S. No Chen et al. (2008) Archival Taiwan No Jenkins and Velury (2008) Archival U.S. No Davis et al. (2009) Archival U.S. No Ruiz-Barbadillo, Gómez-Aguilar, and Carrera (2009) a Archival Spain No Li (2010) Archival U.S. Yes Chi et al. (2011) Archival U.S. Yes b Panel B: Studies using mandatory rotators (cell 1) data Dopuch et al. (2001) Experimental N/A Yes Nagy (2005) Archival US Yes Arel et al. (2006) Experimental N/A Yes Jennings et al. (2006) Experimental N/A Yes Blouin et al. (2007) Archival US No Kealey et al. (2007) Archival US Yes Kaplan and Mauldin (2008) Experimental N/A No Wang and Tuttle (2009) Experimental N/A Yes Daniels and Booker (2011) Experimental N/A Yes c Kwon et al. (2011) Archival Korea No Lowensohn et al. (working paper) Archival US Yes a Since the mandatory rotation policy in Spain was never enforced, we consider the Ruiz-Barbadillo study as being conducted in a voluntary setting. b To be more precise, Chi et al. (2011) find conflicting results. On the one hand, they find that auditor tenure is negatively associated with abnormal accruals. Conversely, they show that auditor tenure is positively related to real earnings management. c Daniels and Booker (2011) report inconsistent results. On the one hand, they find that the perception of independence is higher with MAFR. Conversely, they show that perceptions of audit quality are neither higher, nor lower with MAFR. 10 Myers et al. (2003) and Davis, Soo, and Trompeter (2009) attempt to alleviate concerns about endogeneity with the removal of ‘‘quick-auditor- changer’’ companies from their analyses. ‘‘Quick-auditor-changers’’ are auditor–client relationships that last less than 5 years. J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 111 believed to be associated with reporting quality, govern- ments that rotate issue higher quality reports. Kwon, Lim, and Simnett (2010) investigate the impact of rotation on audit quality in Korea, which began requiring audit firm rotation in 2006. Their analysis suggests that while audit fees increased upon adoption of the mandatory rotation policy, the implementation did not have a statistically sig- nificant effect on audit quality. Due to their controlled nature, experimental studies can be particularly useful when it comes to examining the ef- fect that mandatory rotation may have on auditor indepen- dence and audit quality. Of the six experimental studies listed in Panel B, three investigate whether perceptions of auditor independence are incrementally influenced by MAFR. Specifically, Jennings, Pany, and Reckers (2006) used 49 professional judges and find that auditor independence perceptions are enhanced in a MAFR regime compared to a regime that only rotates audit partners. Similarly, Daniels and Booker (2011) surveyed bank loan officers and find that MAFR improves the perception of auditor independence even though MAFR does not affect their perception of audit quality. In contrast, Kaplan and Mauldin (2008) show that non-professional investors’ perceptions of independence are not significantly enhanced in a MAFR regime (compared to a regime that only rotates audit partners). The remaining three experimental studies examine the impact of mandatory rotation on the quality of the subse- quent audits. For example, Arel, Brody, and Pany (2006) find that auditors in a MAFR regime are more likely to issue modified audit opinions when a departure from GAAP is present. Likewise, Dopuch, King, and Schwartz (2001) find that participants in a MAFR condition are less likely to is- sue biased reports. Finally, Wang and Tuttle (2009) inves- tigate how MAFR affects auditor–client negotiations. Specifically, they find that in a mandatory rotation regime auditors adopt less cooperative negotiation strategies and are more likely to adopt ‘‘obliging’’ strategies in situations when MAFR does not exist. Summary and discussion Table 3 employs a simple 2 Â 2 contingency table to summarize the aforementioned 24 studies based on: (a) whether the key findings provide support for or against a mandatory rotation policy; and (b) whether the study re- lied on mandatory rotators (cell 1) or voluntary changers (cell 3) data. Table 3 reveals that eight of the 11 studies conducted in a mandatory rotation setting provide evi- dence that lends support to a MAFR policy. In stark con- trast, only two of the 13 studies using voluntary changers data provide support for mandatory audit firm rotation. Crude statistical analysis consisting of a chi-square test for independence reveals that support for MAFR depends on whether voluntary or mandatory data was used in the study ( v 2 = 8.07, p-value < 0.01). Further, a simple odds-ra- tio computation reveals that that studies conducted in mandatory settings are 14.661 times more likely to find support for MAFR. For numerous reasons, including the small sample size and lack of control variables, we realize that this analysis is far from rigorous. 11 Nevertheless, it does lend some support to the concern expressed by the PCAOB and some academics regarding whether the empiri- cal results obtained from studies based on voluntary chang- ers would extend to a MAFR setting. The purpose of this manuscript is to provide a critical summary of recent mandatory audit firm rotation research and suggest how it might be useful to regulators as they consider the implementation of mandatory rotation in the U.S. While Stefaniak et al. (2009) conclude that ‘‘a majority of the evidence does not support the implementa- tion of a MAFR regime in the U.S.’’ (p. 108, Section 5.2.5), we show that if one separates the literature into two sub- sets, the results found in the mandatory settings are much more supportive of MAFR. In general, the first subset examines the effect of auditor tenure on audit quality in settings where changing auditors is a voluntary, rather than mandatory, action. More often than not, the conclu- sion from this stream of the literature is that short-tenure audits have inferior audit quality compared to long-tenure audits. However, it is questionable whether the findings of this stream of literature provide much useful guidance to the debate on MAFR because these studies rely on samples of short tenure audits that are not representative of com- panies that would be forced to rotate under a MAFR regime. The second subset of the audit firm rotation literature also examines the association between auditor tenure and audit quality; however, these studies deliberately avoid the use of voluntary short-tenure audits and, instead, use short-tenure audits more likely to represent that which would exist under a mandatory rotation regime. The majority of the studies from this subset of the literature are supportive of a move to MAFR, which is in stark con- trast to the conclusions reached from the studies that rely on voluntary changers data. Consequently, it appears that the conclusions reached about the possible effectiveness of MAFR appear to depend on the type of data (voluntary vs. mandatory) used. For this reason, we believe regulators should focus heavily on the type of data used in past audit Table 3 Summary 2 Â 2 contingency table. Support for MAFR by setting. Setting Support for MAFR? Mandatory (use cells 1 and 2) Voluntary (use cells 3, 4, and 5) Totals Yes 8 2 10 No 3 11 14 Totals 11 13 24 11 We also estimate a logistic regression to assess whether studies conducted in mandatory settings are more apt to find results that support MAFR than studies conducted in voluntary settings. Our dependent variable in the model is SUPPORT, which is a dichotomous variable that equals one if the study’s key findings support MAFR, and zero otherwise. The three independent variables in the model consist of: (1) MANDATORY, which assumes the value of one if the study used mandatory rotators data, and zero otherwise; (2) LOG_SIZE, which is the natural logarithm of the sample size on which the key findings in the study are based; and (3) ARCHIVAL, which equals one if the study was archival in nature, and zero otherwise. The results (not reported) reveal that MANDATORY is positively related to SUPPORT (p-value < 0.05). 112 J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 firm rotation research before extrapolating such research to policy making decisions. In addition, future MAFR re- search should avoid the use of voluntary changers that are known, ex ante, to be different from a random sample of companies and instead focus on settings that are more indicative of a regime with a MAFR policy. Acknowledgement We appreciate the guidance and input from Barry Lewis and Robert Knechel. We also appreciate the helpful com- ments from Ken Bills and the research assistance of Stephen O’Dorisio. Appendix A. A summary of the audit firm rotation literature from 2001 to present. Authors and date Relation examined Sample Primary results Support for MAFR? Dopuch et al. (2001) Audit firm tenure and willingness to issue biased reports An experiment with 72 manager subjects and 72 auditor subjects Auditor independence is higher in the presence of mandatory audit firm rotation Yes Geiger and Raghunandan (2002) Audit firm tenure and audit reporting failures US audits of soon-to- be-bankrupt companies between 1996 and 1998 Longer tenure is negatively associated with audit failures No Johnson et al. (2002) Audit firm tenure and financial reporting quality US audits between 1986 and 1995 Longer tenure does not reduce financial reporting quality No Myers et al. (2003) Audit firm tenure and earnings quality US audits between 1988 and 2000 Longer tenure does not reduce audit quality or earnings quality No Carcello and Nagy (2004) Audit firm tenure and AAERs US audits between 1988 and 2000 Longer tenure is not associated with more AAERs No Mansi et al. (2004) Audit firm tenure and the cost of debt financing US reporting years between 1974 and 1998 Longer tenure is associated with lower cost of debt financing. Therefore, mandatory audit firm rotation may be viewed by the capital markets as unbeneficial No Ghosh and Moon (2005) Audit firm tenure and investor perceptions of earnings quality US audits between 1990 and 2000 Longer tenure does not reduce investor perceptions of earnings quality No Nagy (2005) Forced audit firm change and audit quality Arthur Andersen client audits in 2000 and 2001 compared to former Arthur Andersen client audits performed by the Big N in 2002 and 2003 Discretionary accruals are lower for smaller, ex-Arthur Andersen, clients which provides some support for mandatory audit firm rotation Yes Arel et al. (2006) Audit firm rotation and modified audit opinions An experiment with 105 CPA firm auditors Mandatory audit firm rotation is associated with more modified audit opinions Yes Crabtree et al. (2006) Audit firm tenure and bond ratings for newly issued bonds New US debt issues between 1990 and 2002 Longer tenure does not decrease bond ratings for newly issued bonds No (continued on next page) J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 113 Appendix A (continued) Authors and date Relation examined Sample Primary results Support for MAFR? Jennings et al. (2006) Audit firm rotation and the perception of auditor independence An experiment with 49 National Judicial College judges Perceptions of auditor independence are enhanced with mandatory audit firm rotation Yes Blouin et al. (2007) Forced audit firm change and financial reporting quality US audits in 2002 of former Arthur Andersen clients Financial reporting quality did not improve for Arthur Andersen clients that were forced into new [shorter] tenure audits No Kealey et al. (2007) Prior audit firm tenure and audit fees paid to successor auditors US audits in 2002 of former Arthur Andersen clients The successor audit firm fees are positively related to the number of years the company was a client of Arthur Andersen. This relation is seen as evidence that longer tenure [with Arthur Andersen] is a risk factor priced in the successor audit firm fees Yes Chen et al. (2008) Audit firm and audit partner tenure and earnings quality Taiwan audits between 1990 and 2001 Above and beyond the effects of partner rotation on earnings quality, longer tenure does not reduce earnings quality No Jenkins and Velury (2008) Audit firm tenure and accounting conservatism US audits between 1980 and 2004 Accounting conservatism is reduced in short- tenure audits No Kaplan and Mauldin (2008) Audit firm rotation and the perception of auditor independence An experiment with 55 MBA student subjects Above and beyond partner rotation, mandatory audit firm rotation does not lead to increased perception of auditor independence No Davis et al. (2009) Audit firm tenure and earnings management US audits between 1988 and 2006 Longer tenure is associated with more earnings management in the pre-SOX period, but not in the post- SOX period No Ruiz-Barbadillo et al. (2009) Mandatory audit firm rotation and going concern opinions Spanish audits of financially distressed companies between 1991 and 2000 The existence of a mandatory rotation rule does not lead to an increase in going concern opinions to distressed companies No 114 J.R. Casterella, D. Johnston /Research in Accounting Regulation 25 (2013) 108–116 References Arel, B., Brody, R., & Pany, K. (2006). Findings on the effects of audit firm rotation on the audit process under varying strengths of corporate governance. Advances in Accounting, 22, 1–27. Blouin, J., Grein, B. M., & Rountree, B. R. (2007). An analysis of forced auditor change: The case of former Arthur Andersen clients. The Accounting Review, 82(3), 621–650. Carcello, J. V., & Nagy, A. L. (2004). Audit firm tenure and fraudulent financial reporting. Auditing: A Journal of Practice & Theory, 23(2), 55–69. Appendix A (continued) Authors and date Relation examined Sample Primary results Support for MAFR? Wang and Tuttle (2009) Audit firm rotation and auditor negotiation strategies An experiment with 54 graduate business students Mandatory audit firm rotation is associated with auditors who display less cooperative negotiation strategies with their clients Yes Li (2010) Audit firm tenure and accounting conservatism US audits between 1980 and 2004 Longer tenure is positively related to conservatism, but only for large companies and strongly monitored companies. For smaller companies and weakly monitored companies, longer tenure is negatively related to conservatism Yes Chi et al. (2011) Audit firm tenure and earnings management US audits between 2001 and 2008 Longer tenure is negatively associated with abnormal accruals, but positively related to real earnings management Mixed Daniels and Booker (2011) Audit firm rotation the perception of auditor independence and audit quality An experiment with 207 bank loan officers Perceptions of auditor independence are enhanced with mandatory audit firm rotation. Perceptions of audit quality are unchanged with mandatory audit firm rotation Mixed Kwon et al. (2011) Mandatory audit firm rotation and audit quality Korean audits from 2000 to 2007 Audit quality was unchanged after mandatory audit firm rotation was introduced No Lowensohn et al. (working paper) Mandatory audit firm rotation and audit quality Florida municipal and county audits in 2003 New audits formed by a rotation policy have higher audit quality as compared to the audit quality of long- standing audits that do not have a rotation policy Yes J.R. 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Jeffrey R. Casterella a,b, ⇑ , Derek Johnston a a Colorado State University,