Audit Firm Rotation and Audit Quality: Evidence from the Italian Setting

Accounting

Speaker:Prof Annalisa Prencipe, Associate Professor Department of Accounting, Bocconi University, Italy
Date: Wednesday 30 January 2013
Time: 14:00 - 15:30
Location: Building One: Bateman Lecture Theatre

Further details

Using a setting where mandatory audit firm rotation has been effective for more than 20 years (i.e., Italy), we analyze how audit quality changes during the auditor engagement period. In our research setting, auditors are appointed for a 3-year period and their term can be renewed twice up to a maximum of 9 years. Since the auditor has incentives to be reappointed at the end of the first and the second 3-year periods, we expect audit quality to be higher in the third (i.e. the last) term compared to the previous two. Assuming that a better audit quality is associated to a higher level of reporting conservatism and using abnormal working capital accruals (AWCA), we find that the auditor becomes more conservative in the last 3-year period, i.e. the one preceding the mandatory rotation. The well-known Basu model on timely loss recognition, used as a robustness test, confirms our main results. In an additional analysis, we use earnings response coefficients as a proxy for investor perception of audit quality, and we observe results consistent with an increase in audit quality perception in the last engagement period.