Does Mandatory Audit Firm Rotation Enhance Auditor Independence? Evidence from Spain

TLDR

Spain required audit firm rotation every nine years from 1988 to 1995, but the rule was never enforced, providing a unique context to study its effects. The study aims to test whether mandatory rotation increases the likelihood of auditors issuing going‑concern opinions. The authors analyze audit reports of financially stressed firms from 1991 to 2000, comparing periods with mandatory rotation (1991‑1994) to periods without it (1995‑2000). The analysis finds no link between mandatory rotation and higher going‑concern opinion rates, indicating that reputation concerns drive such opinions while client‑retention incentives do not, thereby supporting arguments against mandatory rotation.

Abstract

SUMMARY: In this study, we document evidence on the impact of mandatory rotation of audit firms on auditor independence using Spanish archival data. Rotation of audit firms every nine years was mandatory in Spain from 1988–1995. Although the rule was never enforced, the Spanish context provides a unique setting to examine the effects that mandatory audit firm rotation has on auditor behavior. We examine audit reports for a sample of financially stressed companies from 1991–2000 to compare audit reporting behavior in a regime with rotation (mandatory rotation period: 1991–1994) and one without rotation (post-mandatory rotation period: 1995–2000). We test two competing hypotheses concerning the impact of mandatory rotation on the likelihood of auditors' issuing going-concern modified audit opinions. We find no evidence to suggest that a mandatory rotation requirement is associated with a higher likelihood of issuing going-concern opinions. Our results suggest that auditors' incentives to protect their reputation have a positive impact on the likelihood of issuing going-concern opinions, while auditors' incentives to retain existing clients did not impact on their decisions in both the mandatory rotation and post-mandatory rotation periods. Overall, our results provide empirical support for the arguments put forward by opponents of mandatory rotation.