The impact of mandatory audit firm rotation on auditor-client negotiations

Mandatory rotation of audit firms has become an increasingly attractive regulatory option to lawmakers in light of a series of recent disastrous corporate accounting scandals. The Sarbanes-Oxley Act of 2002 requires a study of potential effects of such a regulation.; This study investigates how the mandatory rotation of audit firms will affect auditor-client negotiations when there is a disagreement on accounting values to report in financial statements. It is hypothesized that the imposition of mandatory rotation will reduce the auditor's incentive to compromise throughout the entire term of the audit engagement with a client and will also reduce the client's incentive to compromise in the final engagement year. As a result of such changes in the auditor's and the client's incentives to compromise, any regulation that requires mandatory rotation of audit firms may have unanticipated effects on the outcome of auditor-client negotiations, i.e., the financial statements issued to the public.; The study was conducted through experiments in a laboratory setting in which participants assumed the role of a manager (client) or of a verifier (auditor). Using a computerized negotiation system, participants negotiated an asset value to report under one of two manipulated conditions---limited auditor term (i.e., mandatory audit firm rotation) or unlimited auditor term. The effects of mandatory rotation are measured by the rate of agreement between auditors and clients and the agreed-upon asset values. It is found that mandatory rotation results in a lower rate of agreement between auditors and clients and lower agreed-upon asset values.