Partner Rotation and PCAOB Inspections: Effects on End-of-Term Audit Quality

Abstract

I examine the joint effects of two current audit regulations, mandatory partner rotation and PCAOB inspections, on audit quality. In doing so, I respond to Congress's call for research about the effects of the 2002 Sarbanes-Oxley Act's reforms on audit quality. In an experiment using experienced professional auditors, auditors decrease effort in the year prior to mandatory partner rotation and increase effort when there is a high risk of PCAOB inspection. When auditors anticipate both mandatory partner rotation and a high risk of PCAOB inspection, the effect of PCAOB inspection risk mitigates the decrease in effort from mandatory partner rotation, such that the net change in effort is not statistically different from zero. Additionally, partner rotation causes partners to reduce time spent on activities likely to enhance audit quality in favor of documentation. I find no evidence that partner rotation or PCAOB inspections affect auditors' independence, as measured by the magnitude of proposed audit adjustments. Regulators can consider whether required PCAOB inspections may perform the same external review function as the "fresh eyes" of mandatory firm rotation as they debate additional reforms.