Accounting

OR Spectrum (2011) 33:265–285 DOI 10.1007/s00291-010-0221-4 REGULAR ARTICLE

An overlooked effect of mandatory audit–firm rotation on investigation strategies

Wuchun Chi

Published online: 1 July 2010 © Springer-Verlag 2010

Abstract Section 207 of the Sarbanes–Oxley Act of 2002 (hereafter, the SOX Act) passed by the US Congress requires a study of mandatory auditor rotation of registered public accounting firms. In the debate over the costs and benefits of mandatory audit–firm rotation, one cost has been overlooked: that of more aggressive monitoring. Because few countries have put such mandatory rotation into practice, there is little empirical evidence available for analysis of its costs and benefits. My research, therefore, uses an analytical approach to demonstrate that, in a firm that has a wellfunctioning independent board, as required by section 301 of the SOX Act, the board will adopt a more aggressive strategy in investigating the collusion between the manager and the auditor and pay a higher audit fee than it would have done in an environment with no audit–firm rotation requirement. The results of this research alter the balance between the costs and benefits of a mandatory audit–firm rotation requirement and should not be ignored by regulators considering implementing such a requirement. Keywords Sarbanes–Oxley Act · Audit–firm rotation · Audit fees · Investigation strategy 1 Introduction Recent scandals involving accounting irregularities have damaged the credibility of accounting audits. In an attempt to help restore this lost credibility, the US Congress passed the Sarbanes–Oxley Act of 2002 (hereafter the SOX Act). Section 203 of this act mandates audit–partner rotation, and section 207 requires a study of mandatory

W. Chi (B ) National Chengchi University, 64, Zhi-nan Road, Section 2, Wenshan, 11623 Taipei, Taiwan, Republic of China e-mail: wchi@nccu.edu.tw

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rotation of registered public accounting firms.1 This research...