Potential Outcomes of Mandatory Audit Firm Rotation in the US Audit Market

• In Event: Auditing 5

Abstract

This paper discusses a model showing optimal audit firm rotation cycle with least social costs at the expense of auditor's welfare. The sufficient conditions for the optimal cycle are the homogeneity in auditor-client pairs and the concavity of audit learning curve. Then, a counterfactual analysis relaxing the homogeneity condition on the US audit market presents potential outcomes by varying rotation cycles and auditor tiers. The rotation is least welfare destroying for the segment of Big-4 auditor-client pairs with the cycle greater than 8 years. Further, the analysis illustrates a trade-off between potential benefits of portfolio diversification of small auditors and costs of market concentration, and the decreasing scale of the trade-off in the cycle.

Author

• Han-Up Park, Temple University