A recent study by Florian Philipp Federsel, published in the International Journal of Auditing, provides insightful evidence on the impact of audit firm and audit partner rotations on financial auditing within the European Union. The paper explores whether these rotations contribute to a renewed perspective in audits, potentially enhancing audit quality and independence.
Federsel’s research delves into 6,103 firm-year observations of non-financial firms across 29 European countries from 2018 to 2022. The study focuses on „key audit matters“ (KAMs), which are significant issues identified during audits that demand special attention. By analyzing changes in KAM disclosures, the study aims to determine whether audit firm and partner rotations lead to a fresh look at audits.
Key Findings
The study reveals a significant distinction between the effects of audit firm rotations and audit partner rotations:
Audit Firm Rotations: These are associated with substantial changes in KAMs, indicating a pronounced fresh-look effect. When an entirely new audit firm takes over, there is a noticeable shift in the focus areas of the audit, suggesting that new firms are less influenced by previous standardizations and can bring a new perspective to the audit process.
Audit Partner Rotations: In contrast, rotations at the partner level show only limited changes in KAM disclosures. While there are some variations, they are not as extensive as those observed with firm rotations. This finding suggests that while new partners may introduce some new viewpoints, their impact is constrained by the overarching methodologies and pressures within their audit firms.
Implications for Regulatory Practices
The results of this study have significant implications for regulatory bodies considering the merits of mandatory rotation policies. The European Union mandates both audit firm and partner rotations, aiming to bolster auditor independence and skepticism. Federsel’s findings support the notion that firm rotations, in particular, are effective in achieving these goals, as they are more likely to overcome institutional pressures towards standardization and bring genuinely fresh perspectives to audits.
Additionally, the study suggests that the EU’s approach of combining both types of rotations may be beneficial, although the fresh-look effect is more pronounced at the firm level. This insight is crucial for regulators worldwide who are contemplating similar audit reform measures.
Broader Context and Future Research
This research contributes to the ongoing debate on the efficacy of audit rotations, adding to the body of literature with its extensive cross-country analysis. Prior studies have shown mixed results, with some suggesting that only audit partner rotations improve audit quality while others emphasize the importance of firm rotations. Federsel’s study, by incorporating a large and diverse sample, provides robust evidence favoring the implementation of audit firm rotations to enhance audit quality and independence.
For stakeholders, including policymakers, auditors, and corporate governance experts, these findings underscore the need to carefully consider the structure and enforcement of rotation policies. Future research could further explore the long-term impacts of these rotations and the specific mechanisms through which they influence audit quality.
To delve deeper into this important study and its implications, the full paper is available here.