The Effect of Mandatory Audit Firm Rotation on Earnings Management and Audit Fees: Evidence from Iran

Abstract

The present study aims to investigate the effects of mandatory requirements of audit firm rotation on earnings management among companies listed on the Tehran Stock Exchange (TSE). The study population consists of 1030 observations and 103 companies listed on the TSE during the years 2003–2012; moreover, the statistical technique used to test the hypotheses is panel data and pooled data. The results showed that the rule of mandatory audit firm rotation increased accruals-based earnings management (AEM) significantly. In addition, outcomes demonstrated that mandatory requirements of audit firm rotation did not have a significant influence on real earnings management (REM) and audit fees. Overall, our findings proved that the mandatory requirements of audit firm rotation in Iran have not been able to prevent the opportunistic actions of management at a time when they were faced with severe financial problems because of economic sanctions and auditors taking standardized systems-based auditing approaches. This research will make investors and others aware of the fact that mandatory audit firm rotation might be not effective in stopping managers wishing to manipulate the accounting figures. This paper actually suggests that when firms have financial distress, regulatory mechanisms such as audit firm rotation may not have a deterrent role. Our findings give lawgivers a stark warning that the length of an audit firm’s tenure should be based on the features of the audit market structure of each country.

The same network auditor, family business groups and earnings manipulation: an evidence from emerging market

“…The SNA change ( SNA_AUDCH) is not effectively restraining EM practices, as reported in regressions 35 to 40, as displayed in Table 12. These results are in line with the study of Salehi et al (2022), which found that audit firm rotation (switch) did not have any significant influence on EM. According to Salehi et al (2022), audit firm rotation is not a deterrent to EM when firms face financial distress.…”

“…These results are in line with the study of Salehi et al (2022), which found that audit firm rotation (switch) did not have any significant influence on EM. According to Salehi et al (2022), audit firm rotation is not a deterrent to EM when firms face financial distress.…”

“…These results are in line with the studies of Daugherty et al (2013), who reported that audit rotation increases the workload of new audit partners and that new audit partners have less knowledge of their clients as compared to older audit firms. Similarly, Salehi et al (2022) reported that mandatory audit firm rotation did not influence EM estimated under the real activity manipulation (RAM) approach rather than increased discretionary accruals based EM. Furthermore, these findings are consistent with those of Mohapatra et al (2021), who found that auditor switching has no significant impact on audit quality.…”

Is earnings management impacted by audit fees and auditor tenure? An analysis of the Big Four audit firms in the US market

“…While longer auditor tenure may help auditors become more familiar with their clients' operations and thus improve the quality of their audits, it can also result in closer, more amicable relationships with management, potentially compromising auditor independence (Chi et al, 2011). This has given rise to two opposing points of view regarding auditor rotation, with its supporters and detractors (Salehi et al, 2022).…”

“…The scientific literature offers a large number of studies that focus on external threats to independence, especially on the effect of rotations and audit fees (Duong Thi, 2023;Gandía & Huguet, 2018;Lohwasser & Zhou, 2023;Nekhili et al, 2022;Salehi et al, 2022;Usman et al, 2022), with inconclusive results. Some authors, such as Zgarni et al (2016), Choi et al (2022b) and Hoang et al (2022), have even focused on analyzing these threats within the so-called Big Four accounting firms.…”