Rotation of Auditing Firms and Political Costs: Evidence from Spanish Listed Companies

DOIhttp://doi.org/10.1111/ijau.12027
Published date01 November 2014
Date01 November 2014
Rotation of Auditing Firms and Political Costs: Evidence from Spanish
Listed Companies
Isabel María García-Sánchez, Isabel Gallego-Álvarez, Luis Rodríguez-Domínguez,
Beatriz Cuadrado-Ballesteros and Raquel García-Rubio
University of Salamanca,Spain
This study analyses a potential factor behind a change in auditor – thatis, the minimization of political costs – given
that the most important companies are more closely scrutinized and will attempt to prevent political costs resulting
from unfavourable changes in the regulation of auditing activities. For that purpose, we analyse 82 Spanish
non-financial companies during the period from 1996 to 2009. The results obtained emphasize that the rotation of
auditing firms takes place mainly when new regulations modifying or abolishing the current norms for auditing
are discussed and enacted.These findings suggest that the real objective of these firms is to send out signals of good
conduct to the public administration in order to avoid stricter regulation.
Key words: auditing firm, voluntary rotation, regulation, legislation change, political costs
1. INTRODUCTION
In recent years, we have witnessed many international
financial scandals in which the independence of the
auditor has been compromised (Enron, WorldCom,
etc.). These have generated a deep crisis in the control of
business information transparency, which has led to
research studies regarding the rotation of auditors, the
duration of audit contracts, and the implications of these
decisions for the independence and quality of auditreports.
The rotation of auditors has been studied for many
years: we can highlight authors such as Burton and
Roberts (1967), Carpenter and Strawser (1971),
Eichenseher and Shields (1983), Beattie and Fearnley
(1995), García-Benau, Ruiz-Barbadillo and Vico-Martínez
(2000), and Gómez-Aguilar and Ruíz-Barbadillo (2000),
among others. Auditor rotation has been used to explain
the quality of the audit report, for example by Chow and
Rice (1982), Craswell (1988), Citron and Taffler (1992),
Lennox (2000) and Ruiz-Barbadillo and Gómez-Aguilar
(2003) and, more recently, Kwon, Lim and Simnett (2010),
Daniels and Booker (2011), Firth, Rui and Wu (2012) and
Velte (2012). In addition, it has been related to reduced
auditing fees (see Simon & Francis, 1988; Johnson &
Lys, 1990; Gregory & Collier, 1996) and the existence
of opinion shopping practices (Ruiz-Barbadillo &
Gómez-Aguilar, 2007; Stefaniak, Robertson & Houston,
2009). More recently, there has been a line of research that
relates to auditor rotation and the characteristics of
boards of directors (López-Iturriaga & Zarza, 2010).
However, there is no evidence explaining auditor
rotation as a strategic decision of companies.
In this regard, this research aims to extend the
empirical evidence by introducing an additional possible
reason for auditor rotation to those already investigated:
rotation of the auditor as a mechanism designed to
prevent companies from being affected by excessive
public intervention, and thereby to reduce the political
costs. Therefore, auditing rotation, considered as a
positive policy on behalf of regulatory bodies, could be
regarded as a proactive strategy in order to avoid
potential interference from public powers and reduce
the chances of enactment of legislation with negative
repercussions for companies. Therefore, the adoption
of well-considered practices would minimize the
possibilities for the enactment of constraining legal
requirements and norms that limit firms’ behaviour.
Concretely, we extend the political costs theory to the
auditing field. This theory argues that the most important
companies in a country are observed politically. For
example, governments can use the information revealed
by these organizations to determine pricing policies,
identify monopoly situations, or develop legislation in
order to transfer wealth from the company to society
(Leventis & Weetman, 2000). As a result, the political
process itself can affect companies, which may benefit
from or be damaged by different government measures.
This in turn may lead these companies to demonstrate
previous behaviour of compliance with the most
demanding legislation in order to minimize the political
costs, to detract attention from themselves, or to attempt
to avoid more restrictive regulation (Adams, Hill &
Roberts, 1998). In addition, due to the greater market
pressure they are exposed to, they have a greater interest
in presenting favourable audits.
With the purpose of studying whether the prevention
of stricter legislation is behind the auditor shift, we
analysed 723 observations relating to 82 major Spanish
quoted non-financial companies for the period from 1996
to 2009. The use of paneldata methodologies allows us to
control for the unobservable heterogeneity associated
with the inter-annual peculiarities of each company, thus
providing less biased estimates.
Since 1996, Spanish legislation has not imposed any
limits on companies seeking to change auditors, so no
regulatory safeguardsexist to reduce managers’ influence
over auditor changes (Gómez-Aguilar& Ruiz-Barbadillo,
2000, p. 738). Therefore, such a change can highlight the
probability of a firm undertaking strategic behaviour to
avoid receiving a qualifiedaudit opinion (Gómez-Aguilar
& Ruiz-Barbadillo, 2003) or to avoid the enactment of
future regulation that restricts its behaviour, which is
the focus of this paper. We consider voluntary rotation
because political costs are more important without
mandatory rotation and in the non-final years with
mandatory rotation (Wang & Tuttle, 2009).
Correspondence to: Isabel María García Sánchez, Facultad de Economía
y Empresa, Campus Miguel de Unamuno,Edificio FES, 37007 Salamanca
(Spain). Email: lajefa@usal.es
International Journal of Auditing doi:10.1111/ijau.12027
Int. J. Audit. 18: 223–232 (2014)
© 2014 John Wiley & Sons Ltd ISSN 1090-6738

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