How Investors Perceive Mandatory Audit Firm Rotation in Korea

Abstract

Credible audit quality is a precondition for a firm’s sustainability. External auditors offer assurance with regard to the uncertain factors that can jeopardize a firm’s sustainability and provide audit opinions that help investors assess risk. After the global crisis and accounting scandals, mandatory audit firm rotation has been implemented globally. However, few studies have investigated either the cost or the benefit of mandatory audit firm rotation. Prior studies provide only indirect evidence on the effects of audit firm tenure on audit quality/perceived audit quality. By discussing prior arguments, we examine how investors perceive the implementation of mandatory audit firm rotation in Korea. Using a unique and direct setting to examine our research question, we analyze the relationship between firms with mandatorily switched audit firms and the cost of equity capital from 2006 to 2008. We find that the mandatory change in the auditors has a negative association with the cost of equity capital. The results are robust to using the arithmetic mean of the cost of equity capital, lagged control variables, and the manufacturing industry effect. The results indicate that investors perceive that mandatory audit firm rotation provides an environment for qualified audits by enhancing auditor independence and skepticism, and thus decreases the cost of equity capital. This study helps to improve our understanding of the impact of mandatory audit firm rotation the information risk evaluations and provides political implications for policy makers by showing the benefit of mandatory audit firm rotation.

Does CSR affect the cost of equity capital: Empirical evidence from the targeted poverty alleviation of listed companies in China

“…Mao et al [51] use the data of Chinese listed companies to evaluate the effectiveness of different models of the cost of equity capital and find that the ex ante model is better than the ex post model and the PEG model is more effective than other models. In addition, the PEG model is an indicator widely used in many other countries [52,53,20,26,30]. For example, it is used in the USA market [20], Korean market [18] and an international market (30 countries) [30].Thus, we choose the PEG model to calculate the cost of equity capital and use MPEG and OJ models in the robustness test.…”

“…In addition, the PEG model is an indicator widely used in many other countries [52,53,20,26,30]. For example, it is used in the USA market [20], Korean market [18] and an international market (30 countries) [30].Thus, we choose the PEG model to calculate the cost of equity capital and use MPEG and OJ models in the robustness test. R PEG i;t ¼ ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi ffi…”

“…The main test in this paper uses the PEG model to calculate the cost of equity capital. However, the MPEG and OJ models also belong to the ex-ante measurement, which is superior to the ex-post measurement and has been applied by scholars [22,18]. Thus, we use the MPEG model and OJ model to calculate the measures of the cost of equity capital in model (5), and the regression results are shown in Table 4.…”

“…However, little attention has been paid to financing costs, such as the cost of capital. As the cost of equity capital reflects investors' risk expectations for the company [18], it is closely related to corporate finance and sustainable development [18,19]. Research indicates that information disclosure, corporate governance, taxation, and audit quality, among other factors, can influence the cost of equity capital [20][21][22][23][24][25], and some scholars believe that social responsibility report disclosure and assurance can alleviate information asymmetry, reduce investor supervision costs, and thus reduce the cost of equity capital [26,20].…”

Determining the Level of Accounting Conservatism through the Fuzzy Logic System

“…The example of the crisis in the USA related to Enron shows that auditors can be unreliable (Edelman et al 2011). Kim et al (2019) investigate the effect of mandatory audit firm rotation and the conclusion is that mandatory audit firm rotation acts as a bonding mechanism to mitigate agency problems, but the problem of bias in financial reporting exists despite rotations of auditors or other institutional solutions.…”