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Table I.
Sample descriptive
statistics
Audit rm
rotation and
audit quality
427
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y
e
a
r
s
t
h
e
i
n
c
u
m
b
e
n
t
a
u
d
i
t
o
r
h
a
s
b
e
e
n
w
i
t
h
t
h
e
c
l
i
e
n
t
;
F
R
I
S
K
i
s
t
h
e
c
l
i
e
n
t
n
a
n
c
i
a
l
r
i
s
k
a
s
m
e
a
s
u
r
e
d
b
y
t
h
e
Z
m
i
j
e
w
s
k
i
(
1
9
8
4
)
n
a
n
c
i
a
l
d
i
s
t
r
e
s
s
s
c
o
r
e
;
S
I
Z
E
i
s
m
e
a
s
u
r
e
d
a
s
t
h
e
n
a
t
u
r
a
l
l
o
g
o
f
t
o
t
a
l
a
s
s
e
t
s
;
L
E
V
i
s
t
h
e
r
a
t
i
o
o
f
l
i
a
b
i
l
i
t
i
e
s
t
o
a
s
s
e
t
s
;
C
L
E
V
i
s
t
h
e
p
e
r
c
e
n
t
a
g
e
c
h
a
n
g
e
i
n
L
E
V
d
u
r
i
n
g
t
h
e
y
e
a
r
;
R
E
T
U
R
N
i
s
t
h
e
p
e
r
c
e
n
t
a
g
e
c
h
a
n
g
e
i
n
t
h
e
b
o
o
k
v
a
l
u
e
o
f
n
e
t
a
s
s
e
t
s
o
v
e
r
t
h
e
y
e
a
r
;
L
D
I
S
T
R
E
S
S
i
s
a
d
u
m
m
y
v
a
r
i
a
b
l
e
i
n
d
i
c
a
t
i
n
g
i
f
t
h
e
c
l
i
e
n
t
w
a
s
n
a
n
c
i
a
l
l
y
d
i
s
t
r
e
s
s
e
d
i
n
t
h
e
p
r
e
v
i
o
u
s
y
e
a
r
;
I
N
V
E
S
T
i
s
i
n
v
e
s
t
m
e
n
t
s
e
c
u
r
i
t
i
e
s
m
e
a
s
u
r
e
d
b
y
c
u
r
r
e
n
t
a
s
s
e
t
s
l
e
s
s
-
c
u
r
r
e
n
t
d
e
b
t
o
r
s
a
n
d
i
n
v
e
n
t
o
r
y
s
c
a
l
e
d
b
y
t
o
t
a
l
a
s
s
e
t
s
;
F
E
E
R
A
T
I
O
i
s
f
e
e
d
e
p
e
n
d
e
n
c
e
a
s
m
e
a
s
u
r
e
d
b
y
n
o
n
-
a
u
d
i
t
f
e
e
s
d
i
v
i
d
e
d
b
y
n
o
n
-
a
u
d
i
t
a
n
d
a
u
d
i
t
f
e
e
s
p
a
i
d
t
o
t
h
e
i
n
c
u
m
b
e
n
t
a
u
d
i
t
o
r
;
S
C
F
O
i
s
t
h
e
n
e
t
c
a
s
h
o
w
s
f
r
o
m
o
p
e
r
a
t
i
o
n
s
s
c
a
l
e
d
b
y
l
a
g
g
e
d
t
o
t
a
l
a
s
s
e
t
s
;
P
R
I
O
R
i
s
a
d
u
m
m
y
v
a
r
i
a
b
l
e
i
n
d
i
c
a
t
i
n
g
i
f
t
h
e
c
l
i
e
n
t
r
e
c
e
i
v
e
d
a
g
o
i
n
g
-
c
o
n
c
e
r
n
o
p
i
n
i
o
n
i
n
t
h
e
p
r
i
o
r
y
e
a
r
;
B
I
G
_
N
i
s
a
d
u
m
m
y
v
a
r
i
a
b
l
e
i
n
d
i
c
a
t
i
n
g
i
f
t
h
e
r
m
w
a
s
a
u
d
i
t
e
d
b
y
a
B
i
g
N
a
u
d
i
t
o
r
;
L
E
A
D
E
R
i
s
a
d
u
m
m
y
v
a
r
i
a
b
l
e
i
n
d
i
c
a
t
i
n
g
i
f
t
h
e
a
u
d
i
t
r
m
i
s
a
l
e
a
d
e
r
i
n
t
h
e
r
m
s
i
n
d
u
s
t
r
y
;
a
n
d
I
N
D
U
S
T
R
Y
i
s
a
d
u
m
m
y
v
a
r
i
a
b
l
e
f
o
r
r
m
s
i
n
t
h
e
m
i
n
i
n
g
s
e
c
t
o
r
Table I.
MAJ
23,5
428
D
o
w
n
l
o
a
d
e
d
b
y
I
Q
R
A
U
N
I
V
E
R
S
I
T
Y
A
t
0
4
:
5
8
2
0
S
e
p
t
e
m
b
e
r
2
0
1
4
(
P
T
)
G
C
O
D
A
T
e
n
u
r
e
S
I
Z
E
F
R
I
S
K
L
E
V
C
L
E
V
R
E
T
U
R
N
L
D
I
S
T
R
E
S
S
I
N
V
E
S
T
F
E
E
R
A
T
I
O
S
C
F
O
P
R
I
O
R
G
C
O
0
.
0
5
3
7
(
0
.
0
2
4
5
)
2
0
.
0
1
5
6
(
0
.
5
1
4
7
)
2
0
.
2
0
4
3
(
,
0
.
0
0
0
1
)
0
.
2
3
2
7
(
,
0
.
0
0
0
1
)
0
.
1
1
3
0
(
,
0
.
0
0
0
1
)
0
.
0
3
2
0
(
0
.
1
8
0
6
)
2
0
.
1
0
1
6
(
,
0
.
0
0
0
1
)
0
.
1
2
9
8
(
,
0
.
0
0
0
1
)
0
.
0
0
6
2
(
0
.
7
9
4
7
)
2
0
.
0
4
8
5
(
0
.
0
4
2
6
)
2
0
.
1
9
8
4
(
,
0
.
0
0
0
1
)
0
.
0
9
1
1
(
0
.
0
0
0
1
)
D
A
0
.
0
6
2
7
(
0
.
0
0
8
7
)
2
0
.
0
0
6
8
(
0
.
7
7
6
3
)
0
.
0
3
6
5
(
0
.
1
2
6
7
)
0
.
0
2
2
7
(
0
.
3
4
3
5
)
2
0
.
0
1
5
4
(
0
.
5
1
9
3
)
0
.
0
5
7
6
(
0
.
0
1
6
0
)
2
0
.
0
1
0
5
(
0
.
6
6
1
2
)
0
.
0
5
5
3
(
0
.
0
2
0
7
)
2
0
.
1
2
4
0
(
,
0
.
0
0
0
1
)
0
.
0
3
0
3
(
0
.
2
0
5
2
)
2
0
.
5
2
0
3
(
,
0
.
0
0
0
1
)
0
.
0
5
0
1
(
0
.
0
3
6
0
)
T
E
N
U
R
E
2
0
.
0
1
2
1
(
0
.
6
1
4
5
)
2
0
.
0
1
9
4
(
0
.
4
1
8
0
)
0
.
2
1
9
3
(
,
0
.
0
0
0
1
)
2
0
.
0
2
4
7
(
0
.
3
0
2
6
)
2
0
.
1
4
1
5
(
,
0
.
0
0
0
1
)
2
0
.
0
7
5
1
(
0
.
0
0
1
7
)
2
0
.
0
1
6
7
(
0
.
4
8
3
9
)
2
0
.
0
8
6
9
(
0
.
0
0
0
3
)
2
0
.
0
9
6
2
(
,
0
.
0
0
0
1
)
0
.
0
4
0
5
(
0
.
0
9
0
5
)
0
.
0
9
9
8
(
,
0
.
0
0
0
1
)
2
0
.
0
8
8
0
(
0
.
0
0
0
2
)
S
I
Z
E
2
0
.
2
1
1
2
(
,
0
.
0
0
0
1
)
0
.
0
2
0
1
(
0
.
4
0
1
5
)
0
.
1
9
7
6
(
,
0
.
0
0
0
1
)
0
.
0
0
2
2
(
0
.
9
2
6
0
)
2
0
.
3
3
2
6
(
,
0
.
0
0
0
1
)
2
0
.
0
7
1
3
(
0
.
0
0
2
8
)
0
.
0
9
3
3
(
,
0
.
0
0
0
1
)
2
0
.
2
7
1
4
(
,
0
.
0
0
0
1
)
2
0
.
3
1
8
8
(
,
0
.
0
0
0
1
)
0
.
2
6
9
4
(
,
0
.
0
0
0
1
)
0
.
3
4
7
6
(
,
0
.
0
0
0
1
)
2
0
.
0
5
0
7
(
0
.
0
3
3
8
)
F
R
I
S
K
0
.
1
5
5
2
(
,
0
.
0
0
0
1
)
0
.
0
3
6
9
(
0
.
1
2
2
9
)
0
.
0
2
3
2
(
0
.
3
3
2
3
)
0
.
1
1
4
6
(
,
0
.
0
0
0
1
)
0
.
1
0
9
4
(
,
0
.
0
0
0
1
)
0
.
0
2
9
5
(
0
.
2
1
7
2
)
2
0
.
3
1
9
0
(
,
0
.
0
0
0
1
)
0
.
1
5
8
4
(
,
0
.
0
0
0
1
)
2
0
.
1
9
9
3
(
,
0
.
0
0
0
1
)
2
0
.
0
2
8
3
(
0
.
2
3
6
0
)
2
0
.
1
8
2
7
(
,
0
.
0
0
0
1
)
0
.
0
8
0
8
(
0
.
0
0
0
7
)
L
E
V
0
.
1
1
5
7
(
,
0
.
0
0
0
1
)
2
0
.
0
0
0
5
(
0
.
9
8
2
2
)
2
0
.
1
6
7
1
(
,
0
.
0
0
0
1
)
2
0
.
4
6
7
9
(
,
0
.
0
0
0
1
)
0
.
0
1
8
4
(
0
.
4
4
1
5
)
0
.
0
0
2
8
(
0
.
9
0
8
5
)
2
0
.
0
6
9
4
(
0
.
0
0
3
7
)
0
.
0
4
0
9
(
0
.
0
8
7
4
)
0
.
1
0
7
5
(
,
0
.
0
0
0
1
)
2
0
.
0
9
7
7
(
,
0
.
0
0
0
1
)
2
0
.
1
7
2
2
(
,
0
.
0
0
0
1
)
0
.
0
3
1
0
(
0
.
1
9
5
0
)
C
L
E
V
2
0
.
0
1
2
4
(
0
.
6
0
2
8
)
0
.
0
3
3
1
(
0
.
1
6
6
5
)
2
0
.
0
9
4
9
(
,
0
.
0
0
0
1
)
0
.
0
3
5
7
(
0
.
1
3
4
9
)
0
.
0
9
8
7
(
,
0
.
0
0
0
1
)
2
0
.
0
2
2
5
(
0
.
3
4
6
7
)
0
.
2
5
9
8
(
,
0
.
0
0
0
1
)
0
.
1
0
1
5
(
,
0
.
0
0
0
1
)
0
.
0
4
1
7
(
0
.
0
8
1
4
)
0
.
0
1
6
2
(
0
.
4
9
9
6
)
2
0
.
1
0
6
5
(
,
0
.
0
0
0
1
)
0
.
0
1
7
7
(
0
.
4
5
8
3
)
R
E
T
U
R
N
2
0
.
1
1
5
1
(
,
0
.
0
0
0
1
)
0
.
0
3
6
6
(
0
.
1
2
5
5
)
0
.
0
0
7
1
(
0
.
7
6
5
2
)
0
.
1
6
3
9
(
,
0
.
0
0
0
1
)
2
0
.
2
9
7
3
(
,
0
.
0
0
0
1
)
2
0
.
0
9
5
0
(
,
0
.
0
0
0
1
)
0
.
1
4
6
7
(
,
0
.
0
0
0
1
)
2
0
.
1
8
4
7
(
,
0
.
0
0
0
1
)
0
.
0
5
9
5
(
0
.
0
1
2
7
)
0
.
0
8
0
5
(
0
.
0
0
0
7
)
0
.
0
9
2
0
(
0
.
0
0
0
1
)
0
.
0
4
7
4
(
0
.
0
4
7
5
)
L
D
I
S
T
R
E
S
S
0
.
1
2
9
8
(
,
0
.
0
0
0
1
)
0
.
0
3
4
2
(
0
.
1
5
2
9
)
2
0
.
0
8
0
1
(
0
.
0
0
0
8
)
2
0
.
2
7
6
8
(
,
0
.
0
0
0
1
)
0
.
1
1
7
3
(
,
0
.
0
0
0
1
)
2
0
.
0
1
4
6
(
0
.
5
4
1
0
)
0
.
0
0
4
0
(
0
.
8
6
6
5
)
2
0
.
2
9
1
0
(
,
0
.
0
0
0
1
)
0
.
1
4
2
6
(
,
0
.
0
0
0
1
)
2
0
.
0
9
7
4
(
,
0
.
0
0
0
1
)
2
0
.
3
5
0
5
(
,
0
.
0
0
0
1
)
0
.
0
2
4
8
(
0
.
2
9
9
1
)
I
N
V
E
S
T
2
0
.
0
1
3
4
(
0
.
5
7
6
2
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Table II.
Pearson and Spearman
correlations
Audit rm
rotation and
audit quality
429
D
o
w
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l
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d
b
y
I
Q
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A
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5
8
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1
4
(
P
T
)
Variable
Coefcient
estimate Std error Wald x
2
Panel A: full-sample (n 1750)
Intercept 4.3094
* *
2.0190 4.56
TENURE 0.0570
* *
0.0267 4.55
FRISK 0.3071
* * *
0.0692 19.67
SIZE 20.4710
* * *
0.1163 16.41
LEV 0.0038 0.0068 0.31
CLEV 20.0189 0.1391 0.02
RETURN 20.1800 0.2737 0.43
LDISTRESS 0.6623
*
0.4024 2.71
INVEST 21.2595 0.8223 2.35
FEERATIO 0.8203 0.5938 1.91
SCFO 21.2163
*
0.6272 3.76
PRIOR 1.8439
* *
0.7959 5.37
BIG_N 20.6020
* *
0.2984 4.07
LEADER 20.1912 0.4567 0.18
INDUSTRY 0.6559
* *
0.3007 4.76
Log likelihood 594.416
Panel B: switching clients (n 205)
Intercept 10.7286 7.7614 1.91
TENURE 20.1666 0.4192 0.16
FRISK 0.4614
* *
0.2031 5.16
SIZE 20.7299
*
0.4305 2.87
LEV 20.0205 0.0200 1.05
CLEV 0.1401 0.3529 0.16
RETURN 20.8198 0.7122 1.33
LDISTRESS 0.1693 1.3866 0.01
INVEST 1.0830 2.1641 0.25
FEERATIO 23.2259 2.2570 2.04
SCFO 3.2308 2.7457 1.38
PRIOR 2.1499
* *
1.0357 4.31
BIG_N 21.6093 1.0410 2.39
LEADER 29.4295 293.4000 0.00
INDUSTRY 0.6150 0.8476 0.53
Log likelihood 85.751
Panel C: matched non-switching clients (n 1,545)
Intercept 3.8100
*
2.1499 3.14
TENURE 0.0570
*
0.0295 3.74
FRISK 0.2864
* * *
0.0782 13.42
SIZE 20.4556
* * *
0.1247 13.34
LEV 0.0099 0.00741 1.78
CLEV 20.1288 0.1627 0.63
RETURN 20.1550 0.3196 0.24
LDISTRESS 0.7063
*
0.428 2.72
INVEST 21.7941
*
0.9389 3.65
FEERATIO 1.353
* *
0.6602 4.20
SCFO 21.9129
* * *
0.7395 6.69
BIG_N 20.6204
*
0.3303 3.53
LEADER 20.1675 0.4693 0.13
(continued)
Table III.
Logistic regression
going-concern opinion
MAJ
23,5
430
D
o
w
n
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o
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signicant negative coefcient, consistent with the expectation that larger rms will
have more opportunities to get out of nancial difculties, and thus be less likely to
receive a going-concern opinion. LDISTRESS and PRIOR both have positively
signicant coefcients as per expectations, consistent with prior ndings (DeFond
et al., 2002; Choi and Doogar, 2005). Additionally, rms in the mining sector are also
found to have a higher propensity to receive a going-concern opinion, consistent with
many rms in this sector being speculative or loss making rms.
Firms with larger investments (INVEST) and SCFO are less likely to receive a
going-concern opinion, as per expectations, as indicated with statistically signicant
negative coefcients. Firms audited by an industry leader are found to have a lower
propensity to receive a going-concern audit opinion, however, the coefcient estimates
are not signicant at any meaningful level.
Discretionary accruals
Table IV presents the results of the model using DA as the proxy of audit quality.
Again, Panel A provides the results for the full sample, with Panels B and C providing
the results for the switching and non-switching rms, respectively.
The main variable of interest in this study, TENURE, is both economically small
and statistically insignicant. This suggests that there is no signicant change in audit
quality over time, leading to our conclusion that there may be no need to rotate
auditors. Results show that larger clients have higher levels of performance-matched
DA. Consistent with Johnson et al. (2002) and Ferguson et al. (2004), leverage is
positively related to the level of DA. There was a signicant negative coefcient for
cash ow from operations and for rms operating in the mining sector. Companies that
experience higher growth in net assets were found to report lower levels of DA,
although statistically insignicant. This may be similar to industry growth, although
Variable
Coefcient
estimate Std error Wald x
2
INDUSTRY 0.7044
* *
0.3304 4.55
Log likelihood 507.451
Notes: GCO a b
1
TENURE b
2
FRISK b
3
SIZE b
4
LEV b
5
CLEV b
6
RETURN
b
7
LDISTRESS b
8
INVEST b
9
FEERATIO b
10
SCFO b
11
PRIOR b
12
BIG_N
b
13
LEADER b
14
INDUSTRY
*
,
* *
,
* * *
signicant at the 10, 5 and 1 per cent levels, respectively.
GCO is a dummy variable indicating if the rm received a going-concern opinion; TENURE is the
number of continuous years the incumbent auditor has been with the client; FRISK is the client
nancial risk as measured by the Zmijewski (1984) nancial distress score; SIZE is measured as the
natural log of total assets; LEV is the ratio of liabilities to assets; CLEV is the percentage change in
LEV during the year; RETURN is the percentage change in the book value of net assets over the year;
LDISTRESS is a dummy variable indicating if the client was nancially distressed in the previous
year; INVEST is investment securities measured by current assets less-current debtors and inventory
scaled by total assets; FEERATIO is fee dependence as measured by non-audit fees divided by
non-audit and audit fees paid to the incumbent auditor; SCFO is the net cash ows from operations
scaled by lagged total assets; PRIOR is a dummy variable indicating if the client received a
going-concern opinion in the prior year; BIG_N is a dummy variable indicating if the rm was audited
by a Big N auditor; LEADER is a dummy variable indicating if the audit rm is a leader in the rms
industry; and INDUSTRY is a dummy variable for rms in the mining sector Table III.
Audit rm
rotation and
audit quality
431
D
o
w
n
l
o
a
d
e
d
b
y
I
Q
R
A
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4
(
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T
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Variable
Coefcient
estimate Std error t-Stat
Panel A: full-sample (n 1750)
Intercept 20.2259
* * *
0.0334 26.77
TENURE 0.0000 0.0005 20.05
FRISK 20.0114
* * *
0.0018 26.52
SIZE 0.0134
* * *
0.0018 7.36
LEV 20.0004
*
0.0002 21.88
CLEV 0.0038 0.0032 1.20
RETURN 20.0070 0.0065 21.08
LDISTRESS 20.0238
* * *
0.0059 24.02
INVEST 20.1559
* * *
0.0167 29.32
FEERATIO 0.0075 0.0116 0.64
SCFO 20.4625
* * *
0.0149 231.15
PRIOR 0.0572
*
0.0337 1.70
BIG_N 20.0117
*
0.0065 21.81
LEADER 0.0053 0.0070 0.75
INDUSTRY 20.0131
* *
0.0054 22.41
Adjusted R
2
0.3796
Panel B: switching clients (n 205)
Intercept 20.3674
* * *
0.1267 22.90
TENURE 0.0036 0.0030 1.21
FRISK 20.0298
* * *
0.0059 25.05
SIZE 0.0199
* * *
0.0069 2.90
LEV 0.0003 0.0006 0.56
CLEV 0.0140 0.0096 1.46
RETURN 20.0167 0.0180 20.93
LDISTRESS 20.0495
* * *
0.0211 22.35
INVEST 20.1736
* * *
0.0537 23.23
FEERATIO 20.0254 0.0371 20.68
SCFO 20.4301
* * *
0.0463 29.28
PRIOR 0.1063
* *
0.0409 2.60
BIG_N 20.0289 0.0216 21.34
LEADER 0.0079 0.0247 0.32
INDUSTRY 20.0201 0.0181 21.11
Adjusted R
2
0.3472
Panel C: matched non-switching clients (n 1545)
Intercept 20.2102
* * *
0.0342 26.14
TENURE 20.0003 0.0005 20.65
FRISK 20.0093
* * *
0.0018 25.11
SIZE 0.0129
* * *
0.0019 6.86
LEV 20.0004
*
0.0002 21.82
CLEV 0.0023 0.0034 0.67
RETURN 20.0061 0.0069 20.87
LDISTRESS 20.0203
* * *
0.0061 23.33
INVEST 20.1535
* * *
0.0175 28.77
FEERATIO 0.0099 0.0123 0.80
SCFO 20.4711
* * *
0.0157 230.02
BIG_N 20.0117
*
0.0067 21.74
LEADER 0.0031 0.0073 0.43
(continued)
Table IV.
OLS regression DA
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Myers et al. (2003) and Blouin et al. (2005) did not nd any signicant relationship
between industry growth and DA. Firms audited by an industry leader are found to
have higher levels of DA but not at any meaningful level of signicance.
Sensitivity analysis
The TENURE variable was replaced by two dummy variables indicating length of
tenure greater than ve and six years. Untabulated results are consistent with the
earlier results, using both the propensity to issue a GCO and DA as proxies for audit
quality. The implication of these results suggest that contrary to an argument for
mandatory audit rm rotation, the length of audit tenure does not have an
economically or statistically signicant effect on audit quality, as measured by the
level of DA, and the propensity to issue a going-concern audit opinion increases with
the length of audit rm tenure.
Carson et al. (2006) report that since 2001 there has been an increase in the percentage
of rms that receive a going-concern opinion. To test our results to the sensitivity of
changes in audit behaviour, we included a dummy variable for rm years from 2001 to
the end of our sample period. Including this variable does not alter our results.
Conclusions and limitations
Using two proxies for audit quality, being the propensity to issue a going-concern audit
opinion and the level of DA, we nd that audit quality is not negatively affected by
audit rm tenure. Using the propensity to issue a going-concern opinion, the length of
audit tenure actually increases audit quality. However, when using the level of DA to
measure audit quality there is neither an increase nor a decrease in audit quality
conditional on the length of auditor tenure. Given this result, we conclude that there
are minimal, if any, benets of imposing mandatory audit rm rotation onto
Variable
Coefcient
estimate Std error t-Stat
INDUSTRY 20.0111
*
0.0057 21.95
Adjusted R
2
0.3912
Notes: DA a b
1
TENURE b
2
FRISK b
3
SIZE b
4
LEV b
5
CLEV b
6
RETURN
b
7
LDISTRESS b
8
INVEST b
9
FEERATIO b
10
SCFO b
11
PRIOR b
12
BIG_N
b
13
LEADER b
14
INDUSTRY
*
,
* *
,
* * *
signicant at the 10, 5 and 1 per cent levels, respectively.
DA is a measure of discretionary accruals; TENURE is the number of continuous years the incumbent
auditor has been with the client; FRISK is the client nancial risk as measured by the Zmijewski (1984)
nancial distress score; SIZE is measured as the natural log of total assets; LEV is the ratio of
liabilities to assets; CLEV is the percentage change in LEV during the year; RETURN is the percentage
change in the book value of net assets over the year; LDISTRESS is a dummy variable indicating if the
client was nancially distressed in the previous year; INVEST is investment securities measured by
current assets less-current debtors and inventory scaled by total assets; FEERATIO is fee dependence
as measured by non-audit fees divided by non-audit and audit fees paid to the incumbent auditor;
SCFO is the net cash ows from operations scaled by lagged total assets; PRIOR is a dummy variable
indicating if the client received a going-concern opinion in the prior year; BIG_N is a dummy variable
indicating if the rm was audited by a Big N auditor; LEADER is a dummy variable indicating if
the audit rm is a leader in the rms industry; and INDUSTRY is a dummy variable for rms in the
mining sector
Table IV.
Audit rm
rotation and
audit quality
433
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Australian rms. Further, given the costs involved in switching auditor, it does not
appear that mandatory audit rm rotation would be benecial to the market. In order
to address the concerns that have arisen recently around auditor independence and
audit quality, other initiatives are more likely to have a greater impact than imposing
mandatory audit rm rotation.
However, there are other potential benets of mandatory audit rm rotation that we
do not consider in this context which may detract fromthe generalisation of our results.
As indicated prior, audit quality can be divided into perceived audit quality and actual
audit quality (Taylor, 2005). This study only examines levels of actual audit quality.
While we conclude that actual audit quality does not improve for rms that rotate
auditor, the perception of audit quality may indeed have increased. Further research is
required to investigate the perception of audit quality on mandatory audit rmrotation,
as well as total audit quality combining both actual and perceived quality.
The proxies used in this study to measure audit quality, however, are not perfect.
Proxies for audit quality can only be devised in most cases using publicly available
information, and not information known to the auditor. The rst proxy used, that being
the propensity to issue a going-concern report, attempts to capture the level of
independence of an auditor. However, a weakness of this proxy is that the propensity
to issue a going-concern report is conditional on a rm being in need of such a report.
The second proxy for audit quality, that being the level of DA, attempts to capture
the amount of inuence management has over the auditor in the sense that rms with
higher levels of DA are more likely to be able to push the boundaries of generally
accepted accounting principles by manipulating the accrual component of earnings. In
the current study, a performance-matched modied Jones (1991) model has been used
to measure DA, which itself has received criticism in the literature. However, this
model has been shown to outperform other attempts at estimating the level of
manipulation in nancial reporting through accruals.
Additionally, the signal that an audit rm switch sends to the market may be of
interest to investors, and send a valuable signal which mandatory audit rm rotation
would remove. To fully understand the signal, information about the reasons for the
switch, and who instigated the switch, be it the client or the audit rm, would need to
be known. In the Australian environment, however, this information is not publicly
available. Alternatively, mandatory audit rm rotation may increase the perception of
audit quality, which in and of itself is an important component to the efcient
operations of nancial markets.
Notes
1. Calculated as per Carcello et al. (1995): FRISK 24.803 2 3.6 (net prot/total assets) 5.4
(total liabilities/total assets) 2 0.1 (current assets/current liabilities).
2. The measure of nancial distress employed is negative cash ows from operations and/or a
loss after abnormal items.
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Corresponding author
Andrew B. Jackson can be contacted at: a.b.jackson@unsw.edu.au
Audit rm
rotation and
audit quality
437
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