The Impact of Revolving Door Practice and Revolving Door Policy on Nonprofessional Investors' Perceptions of Auditor Independence

• In Event: Research Paper Session—Auditing and AIS

Abstract

There is a longstanding view that auditor independence is threatened when an accounting firm’s ex-auditor gains employment with their audit client. Academic research and accounting regulators express concerns that an accounting firm’s previous working relationship with their client’s senior financial reporting executive may impair the firm’s ability to make unbiased decisions during the audit. These threats are centered on (1) reduced professional skepticism and (2) the ex-auditor’s misuse of audit firm-specific expertise to circumvent the audit process. These concerns precipitated the enactment of Sarbanes-Oxley Section 206 (SOX Section 206, hereafter). However, post-Sarbanes-Oxley research fails to support the theory that the revolving door phenomenon impairs independence in fact (Geiger et al. 2005; Geiger and North 2006), and a void in the literature exists as to whether the revolving door phenomenon impairs independence in appearance. Likewise, prior research questions whether the cooling-off period is warranted (Geiger et al. 2008, p. 56). The present study employs two experiments to examine these issues.

The results of experiment one are inconsistent with conventional wisdom that the presence of a previous working relationship between an accounting firm and the client’s CFO impairs auditor independence in appearance. The results suggest that it is not merely the knowledge of a previous working relationship that impairs investors’ perceptions as to whether an accounting firm will manage earnings. Instead, investors’ perceptions of the CFO’s integrity, concerns regarding the CFO’s attitude towards earnings management, and the perceived ability of firms to make unbiased decisions were significant in driving investors’ perceptions as to whether the accounting firm would support earnings management. Investors also indicated that they perceived lending institutions’ satisfaction with revolving door firms’ independence to be sufficient enough to extend capital to clients audited by revolving door firms. Finally, the absence of a significant difference among nonprofessional investors’ perceptions of revolving door firms’ and non-revolving door firms’ independence and the likelihood that they would engage in earnings management begins to challenge the longstanding theory that the revolving door practice impairs perceptions of auditor independence.

The results also indicate that the absence of a significant difference between the minimal, current, and strong revolving door policy suggests that investors do not perceive revolving door firms’ independence as being significantly stronger from the additional standards.

This study contributes to the literature by triangulating the independence in appearance findings in this study with Geiger et al.’s (2005) independence in fact research.

Author

• Reginald Wilson, University of Southern Mississippi