Editorial: Regulating Audit Quality – Ramifications and Research Opportunities

• Date: 01 July 2016
• Published date: 01 July 2016
• Author: Robyn Moroney
• DOI: http://doi.org/10.1111/ijau.12067

Editorial: Regulating Audit Quality –Ramifications and Research Opportunities

Robyn Moroney

Department of Accounting, MonashUniversity

On taking up the role as an editor of the International Journal of Auditing,I would like to share some thoughts abouttwo

current audit quality issues. There is little doubt that audit quality is an issue much discussed and debated by

practitioners, regulators and academics. What is less certain is what exactly constitutes a quality audit and how it is

best achieved. Regulators, concerned with investor confidence in audited financial statements, have introduced

regulations aimed at enhancing audit quality. As audits are unobservable, audit quality is difficult to assess and so

evaluating the relative success of different types of regulation can be problematic. With a view to helping readers

evaluate research in this area and identify possible research topics, I will focus here on two regulations aimed at

enhancing audit quality: partner rotation and audit inspections.

Key words: Partner rotation, audit inspections, audit quality

PARTNER ROTATION

Partner rotationpolicy is aimed at enhancing an important

element of a quality audit, auditor independence, as it

brings a fresh set of eyes to an audit. It is mandatory in a

number of countries (Lennox, Wu, & Zhang, 2014; Winn,

2014).

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A challenge for researchers is measuring and

comparing audit quality at the partner level. Archival

research into the effect of partner rotation (and tenure) on

audit quality is limited as rotations are only observable in

countries where partners sign their name on the audit

report (Australia, Taiwan and soon to be adopted in the

USA; CTCPA, 2015). Some researchers have found that

rotation (or lower tenure) enhances audit quality (Fargher,

Lee, & Mande, 2008; Firth, Rui, & Wu, 2012; Lennox et al.,

2014). Other researchers have found that rotation has no

impact on audit quality (Chi et al., 2009). Looking at the

effect of partner tenure, rather than rotation per se, some

have found that longer tenure is associated with reduced

audit quality (Carey & Simnett, 2006) while others have

found no impact or an improvement in audit quality with

longer tenure (Chen, Lin, & Lin, 2008; Manry, Mock, &

Turner, 2008).

Experimental research also provi des mixed evidence

on the link between partner rotation and au dit quality.

This research focuses on audi tor behaviour in the lead

up to, or following, a rotatio n. Auditors new to an audit

propose larger audit adjustme nts than continuing

auditors (Hatfield et al., 2011) suggesti ng that rotation

improves independence. Aud itors have been found to

decrease audit effort and increa se partner time spent on

documentation, at the ex pense of other potentiall y

quality-enhancing acti vities, such as substantiv e test

reviews, ahead of a partner rotation (Winn, 2014),

suggesting that it reduces audit quality. Using proprietary

data, Bedard and Johnstone (2010) find that planned

engagement effort increases following a partner rotation,

while in an experiment, Bowlin, Hobson, and Piercey

(2015) find thatthere can be an increase or decrease in audit

effort following a partner rotation, depending upon how

auditors evaluate client management, again enhancing

independence. Interviewed partners acknowledge that

partner rotation enhances independence, but at the

expense of client knowledge (Daugherty et al., 2012).

As client knowledge is critical for every audit, its loss

following a partnerrotation is a concern. Audit firms have

responded by implementing formal transitionprocesses to

minimize disruptions to audits and clients (Ernst and

Young, 2013; PricewaterhouseCoopers, (PwC), 2014;

Deloitte, 2015; KPMG, 2015). One strategy is to minimize

any changes to the underlying audit team at the time of a

rotation. As auditteam data are unobservable, it is difficult

for researchersto measure the impact of a rotation on audit

quality while controlling for audit team characteristics,

such as tenure.

An interestingissue is whether the market perceivesthat

a partner rotation (tenure) impacts audit quality.Using the

earnings response coefficient to proxy perceived audit

quality, Chi et al. (2009) find no evidence that partner

rotations alter investor perceptions of audit quality. Using

an experiment, Kaplan and Mauldin (2008) find that

investors’perceptions regarding auditor independence

are the same followinga partner or a firm rotation. Daniels

and Booker (2011) document evidence that the presence of

a firm rotation policy is positively associated with

perceived auditor independence.

The inconsistent findings in th e partner rotation

literature provides opportu nities for researchers and

challenges for regulators. F or researchers, inconsistent

findings provide an opportuni ty to understand more

about client and audit firm cha racteristics that impact

the ways that partner rotati on (tenure) affects audit

quality and what effect this p olicy is having on investors’

perceptions. It also provides a n opportunity to

understand what may be drivi ng these inconsistencies

and the circumstances where rotati on may enhance audit

quality and the circumstanc es where it may not. For

regulators, inconsistent fi ndings suggest that partner

rotation policy may not always enha nce audit quality.

Rotation research findings provide details of the

circumstances when audit quality may be enhanced, or

not, which can inform future modifications to partner

rotation policy. As rotation is seen as an important

regulatory mechanism in enhancing auditor independence,

International Journal of Auditing doi: 10.1111/ijau.12067

Int. J. Audit. 20:105–107 (2016)

©2016 John Wiley& Sons Ltd ISSN 1090-6738