Further evidence on mandatory partner rotation and audit pricing: a supply‐side perspective

Abstract

This study examines effects of mandatory partner rotation (MPR) on audit fees of Australian‐listed companies. Using a fee changes approach, evidence of fee increases in year of the MPR driven by smaller offices of non‐Big 4 auditors is found, consistent with supply‐side resource constraint arguments. Broadly consistent findings are observed using a fee levels approach. Appointment of inexperienced partners to MPR engagements has no discernible effect on fees. Additional analysis of audit reporting lag indicates fee increases reflect additional audit effort as opposed to a pricing strategy. Overall, the evidence supports recent moves by policy‐makers to soften MPR requirements.

Interim reviews and the association between partner rotations and audit fees

“…Our results are thus broadly consistent with both Stewart et al () and Ferguson et al () in showing higher audit fees for smaller clients partaking in partner rotation. We build on their studies by showing the effect is isolated to rotations at the interim review.…”

“…We build on their studies by showing the effect is isolated to rotations at the interim review. However, as Stewart et al () and Ferguson et al () report opposing results for rotation in the larger client segment, our results suggest that the difference in findings may be attributable to rotations before the annual audit resulting in lower audit fees.…”

“…In column (1) of Table , we run our base model, where our variable of interest is Rotation , and find that partner rotation is not significantly associated with audit fees. This is unexpected given prior evidence showing that audit fees are significantly higher at partner rotation (Ferguson et al, ; Stewart et al, ), but could be attributable to having a longer sample period, where learning effects may reduce the disruption of partner rotation or our sample composition skewing to larger and mid‐sized clients. However, when we disaggregate partner rotation based on the timing (i.e., interim review or annual audit) in column (2) of Table , we find that RotationReview is positive and significantly ( p < .05) associated with audit fees, supporting H1 .…”

“…They also document that there is no association between higher audit fees for partner rotation in mid‐size clients, which they argue is due to greater competition in that market segment. Ferguson et al () also find a greater increase in audit fees for mandatory partner rotations in Australia, and emphasize that the supply‐side costs for partner rotation would be greater for smaller audit firms. Using US data, Sharma et al () document higher audit fees after partner rotations, and that the effect is stronger for clients of non‐Big 4 auditors.…”

“…We also consider the effect of mandatory partner rotation, of which almost exclusively occurs at the interim review, and find higher audit fees for mandatory partner rotations involving non‐Big 4 auditors (Ferguson et al, ; Sharma et al, ).…”