Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan
Mandatory Audit Partner Rotation, Audit Quality, and Market Perception: Evidence from Taiwan*
WUCHUN CHI, National Chengchi University HUICHI HUANG, Syracuse University YICHUN LIAO, National Taiwan University HONG XIE, University of Kentucky 1. Introduction Mandatory audit partner rotation has existed in the United States since the 1970s, when the American Institute of Certified Public Accountants (AICPA) required that audit partners in charge of Securities and Exchange Commission (SEC) audits be rotated at least once every seven years. The Sarbanes-Oxley Act of 2002 (SOX) further strengthens this requirement by mandating a five-year rotation for the lead and concurring partners. An implicit assumption in a policy of mandatory partner rotation is that such rotation enhances audit quality. However, this assumption has not been systematically tested in the literature due to the lack of partner information in U.S. audit reports. Unlike in the United States, audit reports in Taiwan contain both audit firm and audit partner names. Exploiting this institutional feature, Chen, Lin, and Lin (2008) and Chi and Huang (2005) examine the relation between earnings quality and partner tenure. They find that earnings quality tends to increase in partner tenure, consistent with findings in the United States based on audit firm tenure. However, their sample periods are prior to 2003 when partner rotation in Taiwan was voluntary. These studies, thus, do not directly investigate the effect of mandatory audit partner rotation on earnings quality or audit quality. ' In this paper, we use audit data in Taiwan, where a five-year audit partner rotation became de facto mandatory in 2004, to examine the effectiveness of mandatory audit partner rotation in promoting audit quality and perceived audit quality. Inspired by SOX, two principal stock exchanges in Taiwan — Taiwan Stock
* Accepted by Michael Willenborg. An earlier version of this paper was presented at the 2005 Contemporary
WUCHUN CHI, National Chengchi University HUICHI HUANG, Syracuse University YICHUN LIAO, National Taiwan University HONG XIE, University of Kentucky 1. Introduction Mandatory audit partner rotation has existed in the United States since the 1970s, when the American Institute of Certified Public Accountants (AICPA) required that audit partners in charge of Securities and Exchange Commission (SEC) audits be rotated at least once every seven years. The Sarbanes-Oxley Act of 2002 (SOX) further strengthens this requirement by mandating a five-year rotation for the lead and concurring partners. An implicit assumption in a policy of mandatory partner rotation is that such rotation enhances audit quality. However, this assumption has not been systematically tested in the literature due to the lack of partner information in U.S. audit reports. Unlike in the United States, audit reports in Taiwan contain both audit firm and audit partner names. Exploiting this institutional feature, Chen, Lin, and Lin (2008) and Chi and Huang (2005) examine the relation between earnings quality and partner tenure. They find that earnings quality tends to increase in partner tenure, consistent with findings in the United States based on audit firm tenure. However, their sample periods are prior to 2003 when partner rotation in Taiwan was voluntary. These studies, thus, do not directly investigate the effect of mandatory audit partner rotation on earnings quality or audit quality. ' In this paper, we use audit data in Taiwan, where a five-year audit partner rotation became de facto mandatory in 2004, to examine the effectiveness of mandatory audit partner rotation in promoting audit quality and perceived audit quality. Inspired by SOX, two principal stock exchanges in Taiwan — Taiwan Stock
* Accepted by Michael Willenborg. An earlier version of this paper was presented at the 2005 Contemporary
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