Do (Audit Firm and Key Audit Partner) Rotations Affect Value Relevance? Empirical Evidence from the Italian Context

Abstract

This research aims to investigate whether and to what extent investors place more weight on accounting amounts disclosed in annual reports issued by entities that experienced a rotation of the audit firm or of the key audit partner. Analysing a sample of 97 non-financial entities listed in the Milan stock exchange over the period 2006-2014, the paper provides evidence that rotations positively affect the value relevance of accounting amounts. In addition, the paper shows how the audit firm rotation and the key partner rotation act only in part as substitutes, as the former is more capable than the latter of positively affecting the value relevance of earnings and book value. These results provide a theoretical contribution to the literature and have significant implications for standard setters. The rotations, even though could determine a loss of client-specific knowledge, nonetheless improve the value relevance of accounting amounts. New rules that require the key partner rotation have a positive effect as long as they do not consider such rotation as an alternative to the rotation of the audit firm being the partner rotation less capable to affect the value relevance of accounting amounts than the key audit firm rotation.

Auditor Independence and Value Relevance in the European Banking Sector: Do Investor Protection Environment and Corporate Governance Matter?

“…By analyzing 64 Romanian companies listed on the Bucharest Stock Exchange between 2006 and 2014, Robu et al (2016) support this thesis and find that auditor's rotation negatively affects the value relevance of the reported information. In contrast, in a study that focuses on EU countries, Mechelli and Cimini (2017) empirically demonstrate that in the year in which the auditor or the partner rotates, investors consider accounting figures more value relevant than in subsequent years. According to these findings, rotation should increase the value relevance of accounting figures to the extent that investors perceive the new auditor to be more independent than the previous one.…”

“…According to these findings, rotation should increase the value relevance of accounting figures to the extent that investors perceive the new auditor to be more independent than the previous one. Differing from Bamber and Bamber (2009), Mechelli and Cimini (2017) suggest that, in the presence of a rotation, the adverse learning effect affects value relevance judgments less than the deterioration of independence of the previous statutory auditor.…”

“…As is the case for audit firm tenure, it is similarly unclear to what extent partner tenure may affect the relationship between independence and value relevance or, more generally, between independence and accounting quality. Focusing on the European setting, Mechelli and Cimini (2017) show that the change of the key audit partner positively affects the value relevance of earnings and the book value of equity suggesting a negative relationship between audit tenure and accounting quality. In this setting, the VIII Directive n. 2006/43/CE of 17th May 2006, requires mandates to last no longer than 7 years, with a cooling-off period of only 2 years.…”

“…This study is motivated by the contradictory findings of scholars investigating the relationship between statutory auditor’s independence and value relevance, earnings quality or audit quality. Using rotation of the audit firm and of the key audit partner as proxies for independence, Mechelli and Cimini (2017) find an increase in value relevance of accounting amounts. In contrast, while Robu et al (2016) find that audit firm rotation negatively affects value relevance, Litt et al (2014) find a negative relationship between partner rotation and audit quality.…”