Competitiveness of Audit Firms in a Mandatory Rotation Setting: Cross Country Evidence from European Union Countries

• In Event: Auditor Ethics and Independence

Abstract

Mandatory audit firm rotation (MAFR) is suggested as a means to improve auditor independence
and increase the dynamics of the audit market. Regulators and academicians have provided mixed
views related to this policy and the empirical evidence so far has been limited. In this study we
address the competitiveness of audit firms in a mandatory rotation setting for European Union (EU)
countries. We test whether MAFR has an impact on audit fees and whether this impact varies with
different client segments and with the strictness of MAFR implementation. Using an OLS
regression for 27 EU member states between 2016-2018, we find no significant fee reaction to an
auditor change. However, when considering the segmentation of the market, we document
lowballing for new engagements in the large client segment, which is in line with client importance
theory. In addition, consistent with the theory of Beggs and Klemperer (1992), we find that
discounting is pronounced only in countries that allow longer maximum engagement periods
(flexible MAFR). Additional tests suggest that our results are mainly driven by mandatory as
compared to voluntary rotations and by Big 4 auditors as compared to non-Big 4 auditors. Our
findings, especially those related to flexibility of MAFR implementation, have important
implications, which should be useful for regulators, academicians, audit firms and clients.

Author

• Ditmir Sufaj, Katholieke Universiteit Leuven