MANDATORY AUDIT ROTATION: AN INTERNATIONAL INVESTIGATION

This study investigates whether mandatory auditor rotation rules are associated with changes in the quality of audit markets. The variation in audit quality of interest to our study is the amount of unexpected opportunistic discretion in earnings before and after adoption of MAR rules. The more discretion in earnings, ceteris paribus, the lower the audit quality. We use available data from countries that have adopted mandatory auditor rotation (MAR) rules. First, we investigate the debonding effect of an MAR policy (i.e., debonding is goal of rotation rules in an effort to enhance auditor independence in audit markets). We compare all available years of data in the pre-adoption period to all available data in the post-adoption years. In the sample period after adoption of MAR rules, the data show evidence of less earnings management, less managing to earnings targets, and more timely loss recognition compared to the sample before adopting MAR rules. From these results we conclude that the quality (as we have defined it) of audit markets appear to improve, on average, from enactment of MAR rules. We then investigate the allowed discretion in the year before and the year after auditor changes in which rotation rules have been adopted (termed the low client-specific knowledge effect). We find evidence of lower audit quality in both years. The evidence is in star