Forcing companies to periodically change their auditing firms can prove counterproductive, Isenberg accounting professor David Piercey and two colleagues* conclude from their behavioral experimental study, just published in the July/August issue of the American Accounting Association’s journal, The Accounting Review. That’s because mandatory rotation of auditors inhibits rather than encourages their skepticism, the authors observe. “In auditing, skepticism is critical,” emphasizes Piercey. Skepticism should trump seeing the firm through rose-colored glasses or even with neutral dispassion, he says.
When an auditor or auditing firm is new on the job, they face a learning curve in digesting the client’s financial performance and record-keeping practices, as well as establishing productive relationships with key client personnel. Until auditors reach a sufficient experiential threshold with a client, which can take a full reporting cycle or more, they may lack sufficient confidence, and their skeptical prowess will suffer.
There is another side to the story. “Auditors are independent yet paid by the companies that they audit. That will always loom as a conflict of interest in the system,” notes Piercey. To that end, the European Union will require companies, beginning next year, to periodically change accounting firms or rebid audit work. In the U.S., accounting partners associated with an audit must also rotate periodically.
According to Piercey, considerable evidence demonstrates that improved audit performance correlates with an auditor or auditing firm’s longevity on the job. But, he asks, Is it longevity that leads to improved performance or improved performance that drives longevity? “That archival evidence does not establish causality; it’s just based on correlations,” he remarks.
“Fortunately, we can control for reverse causality in experiments that precisely parallel the generic decisions and maneuvering between corporate managers and external auditors,” he continues. To that end, Piercey and his colleagues devised a laboratory experiment simulating manager/auditor pairings. The authors framed different conditions in those relationships that equated with rotational and permanent auditors, their degree of skepticism, and managers’ attempts to influence the interaction. (Explore the experiment’s nuances here.)
The professors’ advice:
“Newly rotated auditors should be extra vigilant in fraud planning and procedures, perhaps focusing on . . . high-quality fraud brainstorming and on falsifying (rather than verifying) management assertions during the audit.”
*Kendall O. Bowlin, University of Mississippi Jessen L. Hobson, University of Illinois at Urbana-Champaign