Faculty Research: Maintaining Auditor Independence

In order to certify a firm’s financial results each year, auditors need to be intimately knowledgeable about that firm while remaining independent and objective. It’s this balance that Christopher Agoglia, Isenberg's Richard Simpson Endowed Professor of Accounting, explores in a recent paper, “Managing the Auditor-Client Relationship Through Partner Rotations: The Experience of Audit Firm Partners.”

 

To maintain independence, lead audit partners are legally required to rotate off a client’s account after five years. Although regulators conceived of such rotations as clean breaks—“essentially handing over the keys,” Agoglia says—the reality is far more nuanced. “Firms try to bridge the transition and put a lot of work into creating continuity and making it run smoothly,” he notes.

 

Do Partner Rotations Provide Fresh Perspective?

 

In the early 2000s, the dangers of client-auditor coziness became clear: Enron collapsed and it emerged that auditing firm Arthur Andersen had been complicit in covering up financial irregularities. The Sarbanes-Oxley Act and other legislation passed in the wake of the scandals limited how long the same lead partner could serve a client, and created a five-year “cooling-off” period where lead auditors could have no further involvement with former clients. But despite these stipulations, regulators allowed audit firms “a great degree of latitude to manage and implement rotations as they see fit,” Agoglia and colleagues write.

 

In their research, Agoglia and coauthors G. Bradley Bennett (Isenberg's associate dean for finance and administration and associate professor of accounting), Mary Kate Dodgson (Northeastern University), and Jeffrey Cohen (Boston College) interviewed 20 U.S. audit firm partners and discovered that firms work hard to create continuity during audit leadership transitions. Common practices include assigning “relationship partners” (senior level liaisons acting as intermediaries and helping mentor the new lead partner), designating a senior manager as successor and having that person shadow the lead auditor for months or even years before the official handoff, and seeking input from the client about what kind of audit partner they prefer. From a business perspective, t­hese activities make sense: A mandatory rotation can be a natural “re-evaluation” point for clients, and accounting firms want to keep the business from being bid out to rivals.

 

However, “bridging” activities could have implications for audit quality, notes Agoglia, who also oversees Auditing: A Journal of Practice & Theory, one of the top publications in the field. On the one hand, transition activities help build trust with the client and ensure that important institutional knowledge is passed between audit teams. This “could be beneficial for the auditor-client relationship,” Agoglia writes. “A stronger relationship between auditors and their clients may help improve audit efficiency and effectiveness to the extent that there is timely sharing of important knowledge between parties.”

 

On the other hand, too much emphasis on keeping clients happy could impact auditor objectivity. “This increased trust and commitment could lead auditors to engage in future downstream residual reciprocation in which they feel the need to respond more favorably to the client in subsequent discussions,” Agoglia writes. This dichotomy may be why studies on audit partner rotation have drawn contradictory conclusions: Some show that auditor rotation improves audit quality and others that it harms it. Agoglia speculates that part of the problem may be how researchers view rotation and advises that future studies “treat audit partner rotation as a process rather than a discrete event.”