Mandatory Audit-Partner Rotation, Audit Quality and Market Perception: Evidence from Taiwan

TLDR

The study examines the effectiveness of Taiwan’s de facto mandatory five‑year audit‑partner rotation, introduced in 2004, in promoting audit quality. The authors use audit data from Taiwan, measuring audit quality with abnormal accruals and earnings response coefficients. Results show that mandatory rotation improves audit quality relative to firms not subject to rotation, yet reduces quality compared to the same firms under their previous partners, is comparable to voluntary rotation, and investors perceive it as enhancing auditor independence.

Abstract

We examine the effectiveness of mandatory audit-partner rotation in promoting audit quality using audit data in Taiwan where a five-year audit-partner rotation became de facto mandatory in 2004. Using both absolute and signed abnormal accruals and abnormal working capital accruals as proxies for audit quality, we find some evidence that audit quality of companies subject to mandatory audit-partner rotation in 2004 is higher than audit quality of companies not subject to rotation in 2004. However, audit quality of companies subject to mandatory rotation in 2004 is lower than audit quality of these same companies in 2003 under the old audit partners. Furthermore, audit quality of companies subject to mandatory rotation in 2004 is indistinguishable from audit quality of companies whose audit partners were voluntarily rotated before 2003. Therefore, the effect of mandatory audit-partner rotation on audit quality, in terms of auditors constraining management's extreme income-increasing or extreme income-decreasing accruals, is mixed. In contrast, using earnings response coefficients as a proxy for investor perceptions of audit quality, we consistently find that investors perceive mandatory audit-partner rotation as enhancing audit quality, suggesting that mandatory audit-partner rotation enhances auditor independence in appearance.