sanders et al - 2009 - facilitating knowledge transfer during sox-mandated audit

Facilitating knowledge transfer during SOX-mandated audit partner rotation Christina Butler Sanders a , Michelle D. Steward b, * , Sheri Bridges b a Dixon Hughes PLLC, 500 Ridgefield Court, Asheville, NC 28806, U.S.A. b Calloway School of Business & Accoun tancy, Wake Forest University, P.O. Box 7285 Reynolda Station, Winston-Salem, NC 27109-7285, U.S.A. 1. Section 203: Why it matters now As implications of Section 203 of the Sarbanes-Oxley Act of 2002 (SOX) manifest, accounting firms and their clients are beginning to feel the brunt of mandatory audit partner rotation. Section 203 of SOX (2002) states: It shall be unlawful for a registered public accounting firm to provide audit services to an issuer if the lead (or coordinating) audit partner (having primary responsibility for the audit), or the audit partner responsible for reviewing the audit, has performed aud it Business Horizons (2009) 52, 573—582 www.elsevier.com/locate/bushor KEYWORDS Knowledge management; Sarbanes-Oxley; Audit teams; Knowledge transfer Abstract Audit teams are responsible for the discovery of the true financial state of a business. The ramifications of the quality of these efforts ripple throughout our economy. Requirements of Section 203 of the Sarbanes-Oxley Act of 2002 (SOX)–— which mandates rotation of the audit team member who bears primary responsibility for the audit–—began to take effect as recently as 2007-2008. The potential for knowledge loss within the audit team via this mandated rotation comes with great costs and risks for all stakeholders, as audit team members possess perhaps the most intimate knowledge of businesses. To aid in the prevention of knowledge loss and the facilitation of knowledge transfer from the outgoing to the incoming partner, we suggest four primary knowledge transfer approaches which may be used together in the post-SOX environment. These approaches are: (1) adequate planning of member rotation far in advance of the deadline for each partner; (2) consideration of strategic fit among the incoming partner, the client, the industry, and the team; (3) improved documentation of the outgoing partner’s knowledge to be shared with the incoming partner; and (4) increased interaction among the rotating partners–—outgoing and incoming–—and the client to assist in the sharing of critical, yet difficult to transfer, tacit knowledge. # 2009 Kelley School of Business, Indiana University. All rights reserved. * Corresponding author. E-mail addresses: csanders@dixon-hughes.com (C.B. Sanders), stewarmd@wfu.edu (M.D. Steward), bridges@wfu.edu (S. Bridges). 0007-6813/$ — see front matter # 2009 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2009.07.004 services for that issuer in each of the 5 previous fiscal years of that issuer. Audit partner rotation is not something new to the accounting industry, as lead partners have been rotating off financial statement audit engagements for almost 30 years (AICPA, 1978). Prior to passage of the Sarbanes-Oxley legislation, however, only the lead partner on a financial statement audit was required to rotate audit clients. This rotation was required every 7 years with a 5 year ‘‘time out’’ period, or the amount of time in which a partner may not be involved with that specific engagement (AICPA, 2004). Firms with fewer than five SEC registrant clients and fewer than 10 partners were exempt from this stipulation. At the time, regu- lators believed this represented the best balance of independence and efficiency. In the wake of early-21 st century accounting frauds, however, regulators increased the requirements with the addition of Section 203 to law. While beefing up safeguards for maintaining objectivity and independence was a motivation for Section 203, an outcome of the rotation is knowledge loss within the audit team as the partner with primary respon- sibility for the audit is required to rotate off the engagement. When SOX was enacted, Section 203 received a lower priority within firms for several reasons. One reason why attention was not immediately paid to Section 203 is that many people did not recognize a drastic change from the pre-Sox environment in which some partners had already been rotating, though with significant exceptions. The main reason Section 203 was not given priority of planning within firms, however, is because accounting firms and public companies alike were very concerned with other, more immediate sections of SOX. Of the 66 pages of SOX, Sect ion 203 represents a single para- graph of less than a fourth of a page, and firms had several years before the requirements took effect. Now, Section 203 has been brought to the forefront because the compliance timeline, as required by law, has arrived. Accounting firms now must comply with the man- dated rotation of Section 203 while simultaneously producing high-quality audits. Audit quality offers reliable and verifiable information that is free from bias (Behn, Choi, & Kang, 2008). High-quality audits result from the ability of auditors to find and report problems (DeAngelo, 1981), and improve specificity of data (Wallace, 1980 ). Central to a high-quality audit is the knowledge possessed by the partner that allows detection of inconsistencies and aids in the volume of judgment decisions which must be made. A challenge presented by Section 203 involves how firms can best preserve the knowledge of the rotat- ing partner. Herein, we address this challenge of knowledge loss by describing procedures for retain- ing knowledge within the engagement team and transferring knowledge from departing to incoming partners. First, we begin by analyzing the knowledge man- agement framework, with a particular focus on the transfer of tacit knowledge. Next, a discussion of job rotation as it relates to professional services is presented, followed by a description of the pre- and post-SOX audit environment. Finally, we outline and explain each of the four knowledge transfer reme- dies that can be used by accounting firms to reduce knowledge loss resulting from the requirements of Section 203. 2. Knowledge management framework The knowledge management framework consists of knowledge creation and acquisit ion, transfer of knowledge, and interpretation and application of knowledge (Huber, 1991; Szulanski, 2000 ). Of these elements, th e transfer of knowledge has been referred to as ‘‘one of the most difficult aspects of the knowledge management process’’ (Tu rner & Mak hi ja, 2 00 6,p.201).Knowledgewith- in firms is inherently difficult to transfer, in part because organizational members do not know who knows what and who needs what particul ar knowl- edge at any given time. Due to the nature of rotation required by SOX Section 203, incoming and ou tgoing partners can be clearly identified, thusthefocuscanbeplacedonthepreventionof knowledge loss through effective knowledge transfer. Within the knowledge management framework, knowledge transfer is an attempt to reconstruct involved, intrica te, and often ambiguous patterns of information. This rich knowledge possessed by partners is valuable to the firm and to the quality of the audit, yet challenging to transfer because it is nuanced, tacit, and multidimensional. Knowledge management research suggests the key to preserva- tion of managerial knowledge in complex organiza- tions lies not in making knowledge systems more effective, but in establishing interactions that are embedded in the processes of the organization (Geisler, 2007). The rotation required by Section 203 disrupts knowl edge management routines, and in particular accentuates the potential disrup- tion of knowledge transfer. The value of knowledge of the client and the client’s environment is evident in research examin- ing audit failures. Such research has found that 574 C.B. Sanders et al. significantly more failu res arise from early-stage client-auditor relationships, when mental models of knowledge about the client are being formed, than from those which are more mature (Geiger & Raghunandan, 2002). Potentially, audit failures arise from lack of information about, and under- standing of, the client. As regards mandatory rota- tion of the partner bearing key responsibility for an audit, as set forth under Section 203, relationships will necessarily be short-circuited; knowledge about the client and the client’s environment accompanies the outgoing partner. The loss of knowledge may be further ampli fied, given the uneven distri bution of knowle dge among audit team members (Vera-Munoz, Ho, & Chow, 2006). Knowledge loss can increase the cost of an audit, as more time is needed, and potentially decrease the quality of the audit. Knowledge is embedded in the routines per- formed by an organization (Szulanski & Jensen, 2004). The challenge for the audit team is how best to retain the intimate knowledge of an outgoing partner when he or she rotates to another team and is replaced by an incoming partner. While recent research has developed general knowledge man- agement strategies for companies across industries (see Geisler, 2007) and has focused on other impor- tant aspects of Sarbanes-Oxley beyond mandated partner rotation (for recent examples see Nadler & K ros, 2008; Piot roski & Srinivasan, 2008; Valenti, 2008), little attention has been devoted specifically to knowledge transfer approaches ac- counting firms may use in response to Section 203. Herein, we center specifically on knowledge transfer st rategi es relevant to the post-SOX–— specifically, post-Section 203–—environment. This is central to a post-SOX environment, given the combination o f m andated rotation of a particularly critical organizational employee and the impor- tance of the outcomes of audit teams for accounting firms, their clients, investors, and the economy. Toward the end of effectively and efficiently facilitating knowledge transfer within audit teams, we later recommend four remedies that accounting firms can implement to help decrease the amount of knowledge loss that occurs. While it is inevitable that some knowledge loss will come to pass upon the mandated rotation of partners, the knowledge transfer strategies presented will help limit this occurrence. Because audit team members transform intellectual inputs into valuable outputs, it is critical that processes and policies are in place to facilitate the transfer not only of technical information related to financial standards and measures, but also of information related to the client and the client’s environment. 3. Mandated rotation and knowledge loss Rotation of employees in a working environment is not a new topic. Rotation can be observed in many fields and industries regardless of the reasons be- hind it (e.g., employee termination, retirement, general employee turnover). However, rarely is ro- tation mandated. Early research in manufacturing suggested job rotation as a means to reduce fatigue and monotony (see Miller, Dhaliwal, & Magas, 1973). Job rotation has also been suggested to increase experience working in different roles, to assist in creating managers who are generalists, and to improve ca- reer development via the knowledge acquired through rotation (Campion, Cheraskin, & Stevens, 1994). While experience gained in different roles may be a useful outcome of job rotation, mandated rotation of employees in the professional services industry necessarily entails the costs and risks of knowledge loss. Across industries, there is much lower interest in rotating jobs among executives as compared to non-managerial employees (Campion, Cheraskin, & Stevens, 1994). An underlying reason for this involves the complexity of jobs assumed by those in managerial positions, and the additional time which is needed to gain expertise. This complexity relates to an audit partner in that the intrinsic specialization of the partner consists of both conscious and subconscious engagement-specific information that is acquired and integrated over time. While employee learning theory suggests that knowledge is gained and accu mulated from job rotation experiences (Eriksson & Ortega, 2006; Ortega, 2001 ), research has focused on junior em- ployees who have not accumulated the depth of expertise that more senior employees–—such as auditors–—have. Biggs, Selfridge, and Krupka (1993) suggest the types of knowledge possessed by auditors include financial knowledge (both of financial measures and company finances); event knowledge (actual and normal events, and company operations); and pro- cedural knowledge (re cognition, reasoning, and evaluation of problems). This knowledge contains general content relevant across clients, as well as rich client-specific information and awareness. Au- dit partners possess an intrinsic specialization that they acquire from their experiences and the rela- tionships that they create with their audit clients. This is the case for those employed in the profes- sional services industry. To perform a high-quality audit, auditors need a high degree of domain- specific knowledge of both the client and the Facilitating knowledge transfer during SOX-mandated audit partner rotation 575 client’s environment (Danos, Eichenseher, & Holt, 1989). Part ners possess intricate mental schemas of rich knowledge pertaining to each client, as well as deep, often non-replicable relationships with the client which bring forth tacit knowledge. Elements of this specialized knowledge will be lost when audit partners are mandated to leave a specific engagement. During a partner’s engagement tenure, he or she develops client-specific knowledge that is difficult to transfer to another partner coming on to the engagement. Partners have rich experience with clients. In some cases, the audit partner may have acquired the client for the accounting firm. In other cases, the audit partner may have worked with a client in years past in an entry-level position with the audit team, and later worked up to the partner level. This results in client relationships which may be decades long. Thus, the relational knowledge held by partners about clients can be vast. This tacit knowledge has been identified as a key factor that disti nguishes top auditors from average auditors (Tan & Libby, 1997). The intrinsic speciali- zation of tacit knowledge has been described as ‘‘subconsciously understood and applied, difficult to articulate, developed from direct experience, and usually shared through highly interactive con- versation, storytelling, and shared experience’’ (Zack, 1999, p. 46). Tacit knowledge is ‘‘not readily articulated and resists codification. It is more apt to be lost through employee turnover’’ (Droege & Hoobler, 2003, p. 53). Conversely, explicit knowl- edge is not ambiguous, can be observed, and is easily articulated. Because of the nature of the specialized, tacit knowledge that partners possess, it is both more challenging and important to attempt to pr eserve as much as possible before partner transition occurs. According to Parise, Cross, and Davenport (2006), knowledge loss brought on by high rates of employee turnover–—voluntary or involuntary–—throughout in- dustries is not being combated and has reached crisis proportions. Audit partners have a high degree of knowledge about clients, including knowle dge of ‘‘quality of people, processes, and business plans’’ that is ‘‘vital for conducting an efficient and effec- tive audit’’ (Knechel, 2000, p. 706). A survey amon g audit firms offers support for this notion: the esti- mated start-up cost for auditors is at least 15% of all costs incurred in cases whereby the auditor has experience in the cli ent’s industry, as compared to 25% for companies whereby the auditor has no such experience (Arrunada & Paz-Ares, 1997). It is this knowledge that is lost during partner rotation if no measures are in place to ensure its transfer. Before we outline the four remedies to ass ist partner knowledge transfer, we first describe the auditor’s environment both pre- and post-SOX to provide a context for the remedies. 4. Financial statement audits and the pre-SOX environment All companies registered with the Securities and Exchange Commission are required, by law, to have their financial statements audited by an indepen- dent public accounting firm. This audit is an assess- ment of the fairness of a company’s financial statements, and is per formed to ensure that the financial statements are in conformance with gen- erally accepted accounting principles (GAAP) as set by the Financial Accounting Standards Board, a governing body. Audits also include an assessment of a company’s internal controls (now required by SOX). Financial statement audits provide third par- ties such as investors or creditors with assurance of the fair presentation of a company’s financial per- formance. Additionally, non-SEC registrants often times have their financial statements audited for reasons other than regulatory compliance; for ex- ample, many private companies are required by creditors or other third parties to have audited financial statements. An independent public accounting firm is engaged by a company to perform an objective audit of its finan cial statements to attest that the documents contain no material misstatements. Auditors perform procedures to provide reasonable assurance that fi nancial statements are fairly presented; however, auditors do not provide absolute assurance, as this would be cost prohibi- tive. These accou nting firms are hired with the interests of a company’s shareholders in mind, and aim to understand the true nature of an entity’s circumstances. Because the company has a discretionary role in hi ring an a ccounting firm, though, companies are often referred to as clients of the accounting firm. Within a public accounting firm, teams are cre- ated to perform the work of these financial state- ment audits, and often serve a large list of clients. Referred to as engagement teams, these cohorts vary depending on the size of the accounting firm and the size of the audit client. A team may work on several clients at one time or, for very large clients, may work on only one client for an unspecified amount of time. The American Institute of Certified Public Accountants (AICPA) requires multiple layers of review for each audit engagement; as a standard industry practice, there are at least four members on any given team, often times several more. 576 C.B. Sanders et al. Table 1 provides examples of the roles of various members of an audit team. As defined by the SEC, an audit partner is ‘‘a partner who is a member of the audit engagement team who has responsibility for decision-making on significant auditing, accounting, and reporting mat- ters that affect the financial statements or who maintains regular contact with management and the audit committee’’ (SEC, 2003). Audit partners are considered the highest level of leadership on an engagement team. These partners have strong cli- ent relationships and the greatest responsibility in the engagement. With these characteristics, audit partners possess great knowledge about the audit clients with whom they are working. Because audit partners have served in their field for several–—on average, 10 to 15–—years, they have gained a tremendous amount of knowledge relating to both public accounting and their firm. 5. A new environment created by SOX Now, post-SOX, the partner with key responsibility for the audit must rotate every 5 years. Although enacted in 2002, the partner rotation rules were not Facilitating knowledge transfer during SOX-mandated audit partner rotation 577 Table 1. Public accounting firm team positions Position Responsibilities Functions Experience Associate Lowest position; works on portions of engagements as assigned; interaction mainly with client’s middle management Works some in the office and a majority at client sites; generally works on one client at a time Zero to up to 3 years experience in accounting; college degree Senior Associate First level of oversight; performs most engagements with little supervision; directs and reviews the work of associates; interaction mainly with client’s middle management Works some in the office and a majority at client sites; generally works on one client at a time Normally a minimum of 2 years up to 6 years of experience; college degree; normally passed the CPA exam Manager Second level of oversight; supervises, reviews, and completes engagements; interaction mainly with client’s top management Works in the office and at client sites; generally works on several clients at a time Normally a minimum of 5 years up to 9 years of experience; college degree; passed the CPA exam Senior Manager Normally equivalent to Manager, with slightly more supervision and review responsibilities; interaction mainly with client’s top management Works in the office and at client sites; generally works on several clients at a time Normally a minimum of 3 years of experience as a Manager; college degree; passed the CPA exam Engagement Partner High responsibility for engagement; interaction exclusively with top management of client Works in the office and at client sites; generally works on several clients at a time Normally a minimum of 3 years of experience as a Senior Manager; college degree; passed the CPA exam Lead Partner Ultimately responsible for engagement; signs off on the engagement; interaction exclusively with top management of client Works in the office and at client sites; generally works on more clients than an Engagement Partner Normally a minimum of 3 years of experience as an Engagement Partner; college degree; passed the CPA exam Concurring Partner Independent reviewer of the work performed by the engagement team; responsibility for final decisions Not associated with the work of the engagement team Roughly equivalent to that of a Lead Partner effective until ‘‘the first day of a company’s first fiscal year beginning after May 6, 2003’’ (SEC, 2003). This means the rules for each audit engagement can vary depending on the year end of the client. A majority of audit clients have a calendar year end; so, mandatory partner rotation rules first came into play starting with the 2004 year end. This indicates that a 5 year rotation would last from 2004 to 2009, with partners required to rotate off the engagement in 2009. The SEC stated, ‘‘Because of the importance of achieving a fresh look to the independence of the audit function, we believe that a 5 year time out period is appropriat e’’ (SEC, 2003). Partners were targeted in the legislation due to their high deci- sion making ability, strong client relationships, and primary responsibility for the engagement. Further, the SEC noted that ‘‘certain other sign ifi- cant audit partners’’ will be subject to a 7 year rotation and a 2 year time out period. Fixing its sights on strengthening auditor independence, the SEC believed this framework would present the optimal balance between audit quality and audit costs, while still maintaining the best interes ts of the public. 6. Keeping knowledge within the team As accounting firms and their audit clients prepare for partner rotation, knowledge transfer ap- proaches are needed to help decrease the costs and risks associated with knowledge loss. Given the volume of decisions in an audit that involve the partner’s judgment, the more the partner can understand about the client and the client’s envi- ronment, the gre ater the degree to which he or she can assess the firm’s true financial condition. Next, we focus on four methods aimed at enhancing knowledge transfer: adequ ate planning, strategic rotation, documentation, and increased interac- tion. Each of the strategies is focused on the part- ner, and three of the four involve the client in some aspects of the remedy. 6.1. Adequate planning One of the most obvious and beneficial approaches toward aiding knowledge transfer in the environment of mandated rotation is adequate planning. Simply stated, the transition of audit partners must be planned well in advance. PricewaterhouseCoopers (2003), one of the four largest American public ac- counting firms, stated in a letter totheSEC on Section 203 that, ‘‘the proposed rotation requirements would cause the firm to have to rotate 181 partners in 88 countries for one large multi-national client.’’ Another accounting firm estimated that over 250 partners in 80 countries would be subject to these requirements (HSBC, 2003). Such comments suggest how critical planning will be to rotate all required partners. Firms and audit clients should plan the rotation from both a logistical and a knowledge transfer stand- point. A firm should decide–—well in advance–— which engagement a partner will rotate on to, and when. This will allow the extant partner and the incoming partner, as well as surrounding employ- ees and the client, to be aware of the scheduled rotation. With this information in mind, partners can begin to interact with one another. Events such as regular meetings and shadowing opportunities are recommended to help acquaint the new partner with the client and the engagement. A degree of tacit knowledge can be learned and shared through practice and observation. Additionally, the audit client should be notified of the rotation schedule and, if possible, take part in pre-rotation interactions between partners to help the client better prepare for the transition. The goal of these early communi- cations is to have the outgoing partner share with the incoming partner as much information as possi- ble, to reduce risks and maintain or increase audit quality. All of these events should occur prior to rotation. From a logistics point of view, rotation may be very costly. Some accounting firms have offices with only one partner, requiring the partner to relocate when it is time for rotation. Further, accounting firms must bear in mind that, in order to keep an audit client, a firm must have two qualified audit partners and two outside concurring reviews to retain clients longer than 5 years. Thus, succession decisions should be made with two considerations in mind. First, the incoming partner should ideally possess experience in the client’s industry. For ex- ample, an outgoing partner of an engagement team auditing a client in the financial services industry should be replaced by a partner who has at some point, preferably as a partner, worked with clients in that industry. As regards many domains, however, there may be only a small number of partners with such industry expertise. In some cases, rotation before the mandated time period may not be ap- propriate. Thus, a second consideration is selection of a partner who has worked with a client (or clients) in the same value-chain or supply-chain. For exam- ple, a partner possessing deep experience with a manufacturing client which produces office prod- ucts may–—if a partner with no manufacturing indus- try experience is available for rotation–—be a suitable partner for a client which is a retailer of 578 C.B. Sanders et al. office supplies and products. We suggest that indus- try experience does not necessarily trump all other types of partner backgrounds. It may be the case that the accounting firm perceives a greater fit with a partner in a related industry that is part of the client’s sup ply-chain. The key point is advanced selection of a partner who can enter the engagement as seamlessly as possible. The transfer of tacit knowledge requires time and multiple interactions between the outgoing and incoming partners. Rotation planning and commu ni- cation of the specifics of the plan–—that is, who will rotate where and when–—afford opportunities for partners to begin communication with one another, which enhances the like lihood of sharing more tacit knowledge between partners. Additionally, change in the leader of a group (e.g., the senior audit partner) has the potential to alter the quality of work (Ballinger & Schoorman, 2007). Therefore, planning in advance not only for the first rotation in year 5, but also for the second rotation the following 5 years, may help to minimize disruption. Vancil (1987) suggests a plan for transition of CEO success that can be applicable to partner rotation. In this framework, a new future leader is identified in advance of the departing leader. The idea behind this is to decrease the element of surprise and confusion associated with the change of leadership (Ballinger & Schoorman, 2007). Thus, advance planning allows the firm to brace for the disruption that is likely to follow. The engagement team and client should be aware of the details of the upcoming transition, and should go through a dis- engagement process; this would include introduc- tions and meetings. It is also possible that me mbers of the engagement team will take on more respon- sibility before and after the transition occurs, to ensure the engagement still operates in an effective and efficient manner. If this is the case, this increase in responsibility should be planned in advance, too. An important aspect of planning relates to involv- ing the client in this transitional process. While SOX was designed in part to increase the independence of audit teams, payment foraudit services and selection of auditors continue to be handled by client organi- zations. Thus, the client’s involvement in the transi- tion process may help maintain confidence in the accounting firm and retain their services in the fu- ture. Specifically, the client should be notified of the change and of the incoming partner’s background. Research in key contact employee turnover suggests that a cus tomer’s relationships with key employees of a s ervice prov ider are often stronger than the customer’s relationship with the firm overall (Bendapudi & Leone, 2002). Clients that value these strong relationships with key personnel tend to have heightened concern about the suit- ability of employees replacing the key contact. The acceptability of a replacement is centered on the potential knowledge gap between the current contact and the replacement employee. This sug- gests t hat, upon learning of impending partner rotation, an audit client could be concerned about the acceptability of t he new partner and the knowledge loss which may occur. In order to address this concern, accounting firms should plan to inform their clients as soon as possible and reassure the client of an adequate replace- ment. Additionally, before rotation, the outgoin g partner should fac ilitate early introductions be- tween the incoming partner and the client. This introduction offers a transition and an implicit ‘‘seal of approval’’ by the outgoing partner, who li kely has the strongest relation ship with the client. 6.2. Strategic rotation As alluded to in the discussion of adequate planning, accounting firms should consider a strategic rotation of partners. Instea d of rotatin g audit partners between various engagements based simply on who is available and their geographical lo cation, succession decis ions should be made weighing fit of the audit partner to engagements. Rotating partners with consideration of fit involves identifying an element of an engagement that matches, on some level, a potential incoming partner’s experience. This consideration of fit should trump attempts to keep the partner with a client until the last month of the rotation timeline. Potential similarities may include the size of the client’s firm; the attitude of its management; operations within the client’s firm; the firm’s indus- try; the length of time the client has been in business; and, the length of time the client has been with the accounting firm. Some aspects of fit may be far more important than others, depend- ing on the client; often times, the client may actu- ally assist in deciding which variables are most crucial. For example, a client may think experience in its industry is far more valuable than experience with similar-sized client firms. Consideration of fit can enhance and speed up the transfer of tacit knowledge, as mental models of the outgoing and incoming auditors share similarities. Common experience on some level between part- ners could come in the form of expertise related to a client’s industry, or to the partners’ prior engage- ments or past work history. In announcing rotating partners, the accounting firm may find it beneficial Facilitating knowledge transfer during SOX-mandated audit partner rotation 579 to highlight these similarities such that partners, team members, and clients have an immediate sense of any aspects of their shared experience. Similarities act as a connector by which knowledge transfer may attach and build. 6.3. Documentation A third approach that an accounting firm may utilize to aid in knowledge transfer between rotating part- ners involves documentation of intellectual capital. Throughout a partner’s tenure on a particular en- gagement, he or she may undertake certain activi- ties–—such as documentation–—which will ease the transfer of knowledge during rotation. By its very nature, tacit knowledge is difficult to codify; yet, because of its high value, companies continue to invest in innovative software and ongoing efforts to capture this often experientially-based type of knowledge. In the current litigious environment, audits have become more rigorous and au ditors thus have even more thorough understanding of the client. Currently, there is a strong trend toward documenting more aspects of an audit. This in- creased documentation, when carried out with the goal of enhancing knowledge transfer, can be advantageous during partner rotation. Parise, Cross, and Davenport (2006) suggest that ‘‘critical knowledge loss is not simply what the departing employees know about their job tasks, but also. . .how they get work done on time’’ (p. 31). To assist knowledge transfer from outgoing to incoming partners, the accounting firm may ask an outgoing partner to document answers to questions such as:  Compared to other clients, are there any policies or procedures of this particular client that may shape the audit in some way?  What are the recurring issues of this client, of which the incoming partner should be made aware?  What processes worked especially well with this client in the engagement?  What decision-making norms of the client are unique, and may influence the transparency of information in some way? The partner’s documentat ion of any issues idiosyn- cratic to the client may help inform the incoming partner and offer a background by which the partner can make assessments of the audit. The questions created by the accounting firm can act as a guide to help capture this tacit knowledge. Significantly, the client should not be involved in this documentation process. It is important to note that this documentation process c aptures critical, client-specific knowl- edge; ho wever, the information may be come lost amongst the vast amounts of documentation re- quired during a financial statement audit. Because of this, it is vital to emphasize that new partners must be allowed time to review all documentation provided by former partners. Aside from general audit purposes, the goal of the mainten ance of separate do cumentat ion is to offer a description of the meta-process of the audit landscape of the client’s firm which can be shared between partners. 6.4. Increased interaction A beneficial approach that can accompany the doc- umentation process is increased interaction, before rotation, between the outgoing and incoming part- ners and the team. The client should be involved in this process as it unfolds. In general, Droege and Hoobler (2003) suggest that knowledge can be preserved throug h the ‘‘promotion of employee interaction, collaboration, and diffusions of non- redundant tacit knowledge’’ (p. 51). One way in which this can be accomplished is through increased partner interaction with the engagement team. Droege and Hoobler note that it is ‘‘a worth- while goal. . .to preserve as much tacit knowledge as possible during key employe es’ tenure’’ (p. 55). Typically, audit partners are not exte nsively involved with the engagement team. Increasing this involvement between the partners and the engagement team, particularly at more strategic points during an audit, can help disperse to the engagement team some of the knowledge possessed by the partner. It has been shown that having a social structure which emphasizes employee interaction can en- hance knowledge transfer, and may aid in decreas- ing the potential loss that can occur during audit partner rotation (Droege & Hoobler, 2003). Increas- ing the amount of client interaction with the outgo- ing and incoming partners and team can be arranged to enhance opportunities for the sharing of tacit knowledge. Additionally, before rotation, the outgoing partner–—due to his or her rich relationships within the client’s organization–—can be asked to facilitate interactions between the new partner and the cli- ent. Close relationships between an auditor and a client have, in fact, been suggested to facilitate the audit process (Arel, Brody, & Pany, 2005). Such 580 C.B. Sanders et al. familiarity creates a sense of reassurance in the eyes of the client, and the client may therefore become more willing to share with the auditor vital infor- mation which may not otherwise be discovered. Interactions among the three stakeholders–—the outgoing partner, the incoming partner, and the client–—can act as a ‘‘passing of the baton’’ mechanism, with the edification of the incoming partner by the outgoing partner. Relational capital is not easily and immediately transferred. However, interactions encouraged by the outgoing partner may act as a signal to the client of continuity of the relationship. Additionally, during client/partner interactions, the incoming partner has an opportunity to build his or her understanding of the complexities of the firm. In particular, during the se interactions, partners should be encouraged to explore potential changes which could add complexity to the audit. Such issues include, for example: the presence and /or change of foreign subsidiaries; the likelihood of litigation or litigation settlements; the change in company growth rate; and indicators or concerns of financial distress. Client/partne r interactions centered around matters such as these are designed to help the incoming partner build a knowledge base from which to make later judgments about the client’s financial status. 7. The time is now As mandated by Section 203 of the Sarbanes-Oxley Act of 2002, accounting firms have recently entered the timeline to begin required audit partner rota- tion. These audit partners possess an intrinsic spe- cialization, with rich tacit knowledge gained during their tenure on a financial statement audit engage- ment. An element of this specialized knowledge will be lost when audit partners are forced to disconnect from a specific engagement. While the entirety of SOX was designed with the intention of safeguarding shareholders from gross negligence of corporate executives, significant costs and risks are associated with implementation of the requirements. Share- holders ultimately bear these costs. If knowledge loss from the mandates is not prevented and man- dated partner rotation effectively managed, these costs to shareholders may increase substantially, reducing the benefits of the very law that was designed for their protection. Herein, we have suggested four approaches that can be utilized collectively by accounting firms and their clients to help effectively prepare for partner rotation, in order to decrease the amount of knowl- edge that is lost. Adequate planning, strategic rotation, documentation, and increased interaction are strategies aimed at preserving valuable knowl- edge possessed by the lead auditor required by Section 203 to rotate from an engagement team. Quality audits are the result of a thorough fact-finding mission of dedi cated audit teams. The effects of audits are felt by mo re than just the accounting firm, their clients, and investors; indeed, the interconnected economy relies on the thoroughness of audits. 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