Auditing: A Journal of Practice & Theory Vol 31, No February 2012 pp 97–114 American Accounting Association DOI: 10.2308/ajpt-10193 An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality Brian E Daugherty, Denise Dickins, Richard C Hatfield, and Julia L Higgs SUMMARY: Using structured interviews and surveys of practicing audit partners, this study examines their perceptions with regard to mandatory partner rotation and coolingoff periods, and how recently enacted, more stringent rules, may negatively impact auditors’ quality of life to the detriment of audit quality Results suggest rotation, in general, increases partners’ workloads and the likelihood of relocation Additionally, results suggest that in response to accelerated rotation (and an extended cooling-off period), partners would rather learn a new industry than relocate Importantly, partners perceive audit quality suffers from retraining, but not from relocating Thus these results suggest an indirect, negative impact, and unintended consequence, of accelerated rotation/extended cooling-off periods on audit quality Keywords: Sarbanes-Oxley; audit partner rotation; auditor independence; audit quality; quality of life Data Availability: The survey instrument is available upon request Individual audit partner responses are confidential INTRODUCTION T his study examines the perceptions of practicing audit partners with regard to mandatory audit partner rotation and cooling-off periods, focusing on how more stringent rules may lead to unintended consequences (i.e., negative impact on audit quality) through their effect on partners’ quality of life Many countries require some form of audit partner rotation and cooling Brian E Daugherty is an Assistant Professor at the University of Wisconsin–Milwaukee, Denise Dickins is an Assistant Professor at East Carolina University, Richard C Hatfield is a Professor at The University of Alabama, and Julia L Higgs is an Associate Professor at Florida Atlantic University The authors thank Larry Abbott, Patricia Arnold, Joe Brazel, Karen Hooks, Leslie Kren, Linda McDaniel, Dan Neely, Scott Showalter, Ehsan Soofi, Wayne Tervo, and an anonymous reviewer from the Midyear Auditing Meeting for their helpful observations and suggestions We also thank workshop participants at The University of Tennessee, North Carolina State University, the University of Central Florida, The University of Montana, Southern Illinois University– Carbondale, and the University of Wisconsin–Milwaukee We are grateful to Logan Wehking and Tim Yang for valuable research assistance, and are especially appreciative of the anonymous firms and practicing audit partners participating in this research Editor’s Note: Accepted by Ken Trotman Submitted: May 2011 Accepted: October 2011 Published Online: January 2012 97 98 Daugherty, Dickins, Hatfield, and Higgs off For example, the European Union currently requires partner rotation every seven years and a cooling-off period of two years, the U.K has a five-year-on, five-year-off policy, and Australia has a five-year-on, two-year-off policy Coincident with the enactment of the Sarbanes-Oxley Act of 2002 (SOX), the U.S shifted from a seven-year rotation with a two-year cooling-off period, to a five-year rotation and five-year cooling-off period (U.S House of Representatives 2002).1 This regulatory change provides a unique setting to investigate the perceptions of partners who have worked under both standards.2 Mandatory rotation of audit engagement partners results in a ‘‘fresh look’’ at client risks and engagement issues, and increases the auditor’s independence, in part at the expense of lost client-specific knowledge (U.S House of Representatives 2002) While these direct effects on audit quality have been discussed in prior literature, in this study we specifically consider how rotation (and changes in rotation rules) influence partners’ perceived quality of life (indirect effects), and how partners may make decisions to optimize their quality of life that may in turn reduce audit quality In 2008, the U.S Department of Treasury’s Advisory Committee on the Auditing Profession (ACAP) heard testimony on partner rotation, including arguments that changes in rotation rules have negatively impacted partners’ quality of life and audit quality (ACAP 2008a) Specifically, the testimony documents partners’ difficulties with reassignments caused by increased rotation and the profession’s growing concern of being able to attract and retain high-quality partners under the current rotation/cooling-off system Testimony also addressed the concern that the revised rules would have a negative effect on technical and sector experience, leading to reduced audit quality To investigate these issues, we first conducted in-depth semi-structured interviews with seven practicing audit partners (most of whom were also managing partners) in various geographic locations, to better understand the current environment with regard to mandatory rotation and how the revised rules are affecting practicing partners Based on these interviews, we developed a model of the effects of mandatory rotation on audit quality and created a field survey completed by 370 audit partners to test the model A key aspect of this inquiry (and a key concern raised by all of the interviewed partners) is how partners’ quality of life may be impacted by regulations, and how partners manage their career and personal life while operating under the revised regulations It is these quality-of-life decisions that potentially result in unintended negative impacts on audit quality when the partner is subject to the new rotation requirements Our study contributes to the literature by focusing on mandatory rotation’s influence on audit partners’ perceived quality of life and audit quality based on partners’ perceptions of rotation rules in effect in both the pre- and post-SOX periods While anecdotal information from audit partners (e.g., ACAP testimony) suggests the potential audit quality effects considered here, this is the first study to develop this relationship explicitly and provide evidence consistent with this expectation Our research also allows for a unique comparison of seven-year versus five-year rotation (and two year versus five-year cooling off ) that may be informative as the consequences of mandatory rotation continue to be debated, both in the U.S and in the international community, and as the auditing profession continues toward international convergence of auditing standards Results of the interviews and field surveys suggest, in general, that partners perceive some direct effects of rotation on audit quality Consistent with prior research, rotation is viewed as improving independence resulting in a positive impact on audit quality However, the reduced client-specific knowledge is perceived to negatively impact audit quality Beyond these direct The revised rotation and cooling-off mandates now extend to the concurring partner—now known as the quality review partner (PCAOB 2009)—unlike the previous rotation requirements The new requirements became effective for fiscal years beginning on or after May 6, 2003 (SEC 2004) For calendar-year companies, the new requirements require initial partner rotations no earlier than calendar 2004 audits, and no later than calendar 2009 audits Our participating partners average 11 years as an audit partner Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 99 expectations, our results suggest the SOX-imposed accelerated rotation and extended cooling-off mandates may have an indirect effect on audit quality as well Partners believe that audit quality is maintained by relocating to maintain industry expertise, but perceive audit quality suffers when partners opt to gain new industry experience in order to avoid relocation However, due to quality-of-life issues, partners report being more likely to opt to retrain rather than relocate That is, the preferred response to rotation (if necessary) is to choose an option that they perceive to have a negative effect on audit quality in order to preserve their quality of life These inferences are made more evident by the fact that, in general, partners believe rotation increases the likelihood of relocation, yet they believe that accelerated rotation (five years) will not increase the likelihood they will relocate, though it will increase the likelihood they will opt to gain new industry experience Consequently, the SOX-accelerated rotation appears to increase the likelihood that partners will specialize in multiple industries, at the expense of industry depth and to the detriment of audit quality as reported by our practicing audit partners Further, partners report a two- to three-year new-client familiarization period before they are fully effective on new engagements, increasing the amount of time audit engagements suffer from ‘‘start-up’’ efficacy concerns In contrast, while partners participating in our research perceive rotation generally improves auditor independence, they not perceive accelerated rotation (and an extended cooling-off period) further enhances independence The remainder of the paper is organized as follows The next section expands on mandatory rotation issues brought before ACAP, discusses the results of our semi-structured interviews with partners, and develops a model of direct and indirect effects of mandatory rotation and related hypotheses based on these discussions The third section discusses the study’s field survey methodology Results are presented in the fourth section, and the last section provides conclusions and suggestions for future research MANDATORY ROTATION ISSUES BROUGHT BEFORE ACAP Many countries have mandatory audit engagement partner and/or audit firm rotation requirements The primary rationale for rotation is that it results in a ‘‘fresh look’’ at client and engagement issues and increases auditor independence, in part at the expense of lost client-specific experience (U.S House of Representatives 2002) Accordingly, it is not surprising that the extant research is split on whether audit quality is improved by rotation For example, audit partner rotation was found to improve auditor conservatism (Hamilton et al 2005) and audit quality (Cameran et al 2009) in regimes mandating audit partner rotation On the other hand, Geiger and Raghunandan (2002), Myers et al (2003), and Johnson et al (2002) all found audit and financial reporting quality and audit firm tenure to be positively related; and Jackson et al (2008) found the likelihood of an auditor issuing a going-concern opinion increases with audit firm tenure Although changes to regulations, such as mandatory rotation, may appear to address specific concerns (e.g., auditor independence), consideration must also be given to the potential for negative and unintended consequences as behaviors change in response For example, literature dealing with the unintended consequences of new regulations suggests careful consideration must be given to ‘‘second order’’ effects resulting from altered behavior of decision makers, which may be contrary to the original intent of regulators (e.g., Kolev et al 2008; Bruggemann et al 2010; Lambert et al ă 2011) Of particular interest in this study is how quality-of-life considerations may influence practicing audit partners’ behavior as they adjust to accelerated rotation and lengthened cooling-off periods In an effort to examine the U.S audit profession post-SOX, ACAP was formed A number of stakeholders provided testimony and commentary to ACAP regarding partners’ quality-of-life and audit quality issues surrounding the SOX rotation mandates For example, Brian Jennings, CFO of Auditing: A Journal of Practice & Theory February 2012 100 Daugherty, Dickins, Hatfield, and Higgs Energy Transfer Partners, testified that, given the rise of dual careers, coupled with family requirements and location preferences, partner development and retention will be affected and will potentially harm sector specialization.3 Further, the Center for Audit Quality (CAQ 2008, 5) discussed partners’ quality-of-life issues, suggesting ‘‘more frequent rotation of partners poses significant logistical and human capital challenges for firms, and will likely result in at least one more relocation in the typical partner’s career.’’ Wayne Kolins, BDO Seidman’s national director of assurance, testified that the revised partner rotation requirements may impair the ability of firms to assign the most qualified audit partners to specific audits, noting the rules seem to imply ‘‘each accounting firm has an unlimited and interchangeable supply of suitably qualified partners with the same level of skills and industry expertise in every office’’ (Kolins 2008, 16) Additionally, smaller firms may be affected more, given the potential for a limited number of partners with sufficient industry expertise.4 Semi-Structured Partner Interviews In an effort to better understand how issues such as those raised by ACAP and the CAQ may influence the effect that rotation has on audit quality, we conducted semi-structured interviews with seven practicing audit partners from seven different firms, six of whom were office managing partners (OMPs) from various geographic locations and from differing office sizes The other partner was a leading industry specialist, selected to assist in development of the field survey statements relevant to industry expertise Data from these interviews were used to develop a model (Figure 1) that demonstrates: (1) how rotation is generally perceived to influence audit quality through its direct impact on client-specific knowledge and auditor independence, and (2) how indirect effects caused by quality-of-life issues brought on by more stringent rotation rules may also affect audit quality Consistent with the approach employed by Hirst and Koonce (1996) and Beasley et al (2009), the use of semi-structured interviews allowed us to delve further into the partners’ responses to develop the study’s model A standard script guided the interviews Each interview lasted in excess of an hour, was attended by at least one of the authors, and notes were taken We explained that the purpose of the research was to explore perceptions of mandatory partner rotation—including the SOX-mandated changes—on quality-of-life and audit quality issues Partners were interviewed separately and could elaborate on any issue they chose In general, interviewed partners felt the prior rotation rules (seven years on, two years off ) achieved the benefits of a fresh look at engagement issues such as audit scopes and risk assessments They also agreed that improved independence is important However, when discussing the SOX-imposed rotation rules, they brought up two issues concerning possible negative impacts on audit quality The first issue concerns the time required to get ‘‘up to speed’’ on a new audit engagement Accelerating rotation from seven to five years on any audit client may lead to only two years of highest audit quality, as it takes approximately two years for a new partner to get fully up to speed, and partners potentially lose some efficacy in the year before they rotate off an audit engagement as they spend time ‘auditioning’ with audit committees of potential successor audit clients This concern was presented in several ways, but consistently came up in discussions with this high-level group of partners See testimony of Brian Jennings on February 4, 2008 (ACAP 2008b, 22–25) and the June 3, 2008 ACAP meeting minutes (ACAP 2008c, 278) The CAQ also noted that concurring partners generally bring deep industry expertise to an audit and play an important role in the overall quality of public company audits (CAQ 2008) As SOX rotation requirements now extend to concurring partners, there is an increased likelihood that their substantial industry expertise may be diminished by the new rotation requirements We use the ACAP findings in the formulation of the study’s model Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 101 Second, interviewed partners voiced their ‘‘primary concern’’ to be how accelerating rotation (and extending cooling off ) affects the quality of life of their partners Interviewed partners believe relocations would necessarily increase (e.g., one partner stated that the average career would have at least one additional relocation due to the SOX revisions) They also believe partners likely manage their careers to minimize the potentially negative personal impact of relocation This can be accomplished by having a greater breadth of industry specialization—though potentially at the expense of industry depth Several anecdotal stories were given describing how the current generation of newer partners are resistant to relocation and are emphasizing quality of life over compensation One key factor is ‘‘spouse equality,’’ where both spouses are equally educated, having similar earning power, such that moving is not as economically necessary as it once was Also, parents of younger children face the possibility of changing their children’s’ school up to three times under the revised rotation rules (compared to once or twice under the prior rules) For example, one spouse refused to move, requiring the rotating partner to commute long distances Our interviewed partners consistently assessed this as a sub-optimal response, leading to poorer client service and lower audit quality In an attempt to avoid relocation, interviewed partners provided examples of engagement partners training in new industries which could slow their advancement opportunities and reduce audit quality They also cited examples where partners avoided relocation by taking on less prestigious clients, again emphasizing quality of life over career progression Finally, a key concern of these interviewed partners is that highly rated partners, and highly rated senior managers on the partner track, may forgo a career in public accounting to avoid these issues, stating negative perceptions of the revised rotation rules appear to grow more pronounced as the auditor’s level in the firm rises Most of these partners stated they believe these issues to be exacerbated in smaller firms and smaller offices of large firms, with few or even a single large prestigious client(s) Model of Direct and Indirect Effects of Rotation, and Development of Hypotheses Based on the in-depth partner interviews, the ACAP testimony, and prior literature, we developed a model (Figure 1) that includes both the direct effects of mandatory rotation on audit quality due to shorter audit partner tenure5 and increased independence, and the potential indirect effects on audit quality intimated by the discussion of partners’ quality-of-life concerns The model displays the secondary linkage between shorter rotation and longer cooling-off periods and audit quality Prior literature has suggested direct effects on audit quality due to increased independence, a ‘‘fresh look,’’ and reduced client-specific knowledge Our model suggests that, beyond these direct links, rotation/cooling-off mandates affect a partner’s quality of life, and that these quality-of-life issues will lead partners to respond to rotation requirements by learning new industries rather than relocating Finally, the model shows that such a choice ultimately has a negative effect on audit quality The study’s hypotheses are based on the key links in this model Direct Effects Shareholders engage independent auditors to reduce the likelihood that managers will engage in opportunistic behavior (e.g., perquisite consumption and shirking) at their expense (Jensen and Meckling 1976) DeAngelo (1981) theorizes the quality of the independent auditor’s work is dependent upon the auditor’s ability to both detect and report identified financial statement errors Financial reporting quality and audit firm tenure are positively related (Myers et al 2003), and audit quality is lowest in the first three years of a firm’s tenure, and highest in years four through eight (Johnson et al 2002) Accounting and Auditing Enforcement Releases related to fraud are positively associated with shorter firm tenures (Carcello and Nagy 2004a) Auditing: A Journal of Practice & Theory February 2012 102 Daugherty, Dickins, Hatfield, and Higgs FIGURE Model of Direct and Indirect Effects of Mandatory Rotation on Audit Quality Prior research has confirmed a positive association between auditor expertise and audit quality For example, client-specific experience, a proxy for expertise, enhances auditors’ ability to respond to fraud indicators (Brazel et al 2010); and industry expertise has been found to be positively associated with financial reporting quality (Carcello and Nagy 2004b; Krishnan 2003, 2005) While behavior modeling research (DeAngelo 1981) theorizes that auditors have incentives to collude with managers and not report identified financial statement misstatements in an effort to retain the audit, research in support of this proposition is not convincing Summarizing much of prior research investigating the relationship between non-audit fees and audit quality, Moehrle and Reynolds-Moehrle (2006, 2007) suggest the evidence is inconclusive Using the audit partner’s engagement tenure as the proxy for independence, Simnett and Carey (2006) found a negative relationship between auditor independence and the likelihood of issuing a going-concern opinion; and Hatfield et al.’s (2011) results suggest a positive association between audit firm and audit partner changes and the magnitude of proposed audit adjustments.6 When audit engagement partners rotate, absent effective knowledge-transfer strategies, clientspecific explicit and tacit knowledge may be lost, to the detriment of audit quality Accelerating audit engagement partner rotation and extending cooling-off periods may accentuate this issue; hence, we expect: H1: Audit partners perceive auditor rotation (and accelerated rotation and longer cooling-off periods) to have a negative impact on auditor client-specific knowledge Dickins and Skantz (2010) propose these differences may be dependent upon who de facto monitors the auditor, managers or the independent audit committee In the post-SOX period, when independent audit committees are explicitly responsible for monitoring independent auditors, decreases in incumbency quasi-rents (e.g., non-audit fees) act to reduce auditor incentives to maintain their independence and report identified errors Similarly, decreases in technological advances gained by repeat engagement experience are predicted to reduce auditor incentives to remain independent Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 103 Consistent with DeAngelo’s (1981) proposition, mandatory partner rotation reduces the bond between audit partners and their clients That is, longer associations between audit partners and their clients can create personal relationships that make it more difficult for the auditor to act independent of the preferences of the client Accordingly, we hypothesize: H2: Audit partners perceive auditor rotation (and accelerated rotation and longer cooling-off periods) to have a positive impact on auditors’ independence Indirect Effects Like all individuals, audit partners strive to achieve personal satisfaction, which includes maintaining a satisfactory work/life balance; minimizing conflicts with family members’ goals, wishes, and geographic preferences; and living in a desirable location Quality-of-life issues, including job-related stress, burnout, job satisfaction, and turnover intentions have been recognized as important in the public accounting profession Research has considered how such quality-of-life issues influence professional commitment and stress (e.g., Hall et al 2005; Bernardi 2003), and how quality-of-life issues are exacerbated when a working spouse and/or children are involved (e.g., Jackson et al 1985; Parasuraman et al 1989) Our structured interviews, as well as the testimony heard by ACAP, suggest increasing the frequency of rotation for audit partners will negatively impact audit partners’ quality of life (link A in Figure 1); hence, we hypothesize: H3: Audit partners perceive auditor rotation (and accelerated rotation and longer cooling-off periods) to have a negative impact on their quality of life As previously discussed, the semi-structured interviews provide anecdotal evidence that partners may put quality-of-life issues above career advancement opportunities, particularly in the presence of a working spouse and/or children Relocating can lead to many of the stressors discussed above, and commuting may not be a viable alternative given Jackson et al.’s (1985) finding that commuting contributes to dissatisfaction with job/family congruence Partners could avoid some of these issues by retraining rather than relocating (link B in Figure 1) Further, research tracking social and generational trends suggests Generation X, individuals born between 1965 to 1976—who have or would be reaching the partner level now—are more family oriented than previous generations (NAS 2006) and are therefore likely to put quality-of-life issues ahead of career considerations; hence, we hypothesize: H4: In response to shorter rotation (and longer cooling-off ) periods, partners perceive retraining has a better outcome on their quality of life than relocating Some of the interviewed partners indicated audit quality may suffer beyond the direct effects of shorter engagement partner tenure and extended cooling off, in that the preferred alternatives to relocation may have a negative effect on audit quality For example, retraining in new industries can lead to several issues, including the possibility that an auditor’s ability to detect errors increases with expertise and industry knowledge, as confirmed by prior research For example, client-specific experience enhances auditors’ ability to respond to fraud indicators (Brazel et al 2010); and industry expertise has been found to be positively associated with financial reporting quality (Solomon et al 1999; Krishnan 2003, 2005).7 Reflective of link C in Figure 1, and as further detailed in Figure 2, we hypothesize: In support of the notion that auditors’ industry expertise is important to clients, Blouin et al (2007) documented that a number of Andersen’s former audit clients did not engage a new audit team following the firm’s demise, but rather followed their former audit engagement team to the successor auditing firm, especially when Andersen was viewed to be the industry leader in the local market Auditing: A Journal of Practice & Theory February 2012 Daugherty, Dickins, Hatfield, and Higgs 104 FIGURE Learning a New Industry versus Relocating H5: In terms of audit quality, partners perceive relocating is a better outcome than retraining METHODOLOGY The field survey was distributed to 370 practicing partners from 14 firms, representing approximately 40 distinct practice office locations of varying size Partners solicited to complete the field survey were identified through contacts known to the authors in a variety of geographic locations For larger firms, this typically involved having a contact partner distribute the survey to all audit partners in a specific practice location Further, one of the eight largest firms and two of the top 25 firms consented to a nationwide distribution of the survey to all U.S audit partners Of the surveys distributed, 170 (46 percent response rate) were returned, comprising 37 Big partners (21.8 percent of the sample), 86 midsize firm partners (50.6 percent of the sample), and 47 partners from other firms (27.6 percent of the sample).8 All respondents had public company audit experience with firms subject to mandatory rotation RESULTS Demographics of Field Survey Participants Table provides demographic data of the audit partners participating in the field survey Eighty percent of surveyed partners are male and 90 percent are married; they average 47 years of age and have been an audit partner for 11 years.9 Partners reported expertise in an average of 2.6 industries and served as lead (concurring) partner on an average of 1.7 (1.8) public audits during the past year Partners report an average of 2.14 children (averaging 1.41 under the age of 18).10 The only significant demographic differences by firm size (not tabulated) relate to the number of expert industries (p , 0.05), number of public companies served as lead (concurring) partner in the prior year (p , 0.001 (p , 0.01)), and the number of assurance partners (p , 0.001) in the local practice Consistent with ACAP’s view that the burden of rotation was on smaller firms and practice offices (excluding exempt firms), differences noted are generally driven by the Big and/or midsize firms as compared to the other partners Collectively, our partner participants are in offices 10 These response rates compare favorably to those of other survey-based auditing research (e.g., Bamber and Iyer’s [2007] 23 percent, DeZoort and Salterio’s [2001] 20 percent, and Brazel et al.’s [2010] 48.8 percent response rates) Thus, most of our surveyed audit partners practiced in both the pre- and post-SOX rotation environments Inclusion of these variables in the analyses does not change the results of any of the hypothesized effects Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 105 TABLE Demographic Data of Surveyed Audit Partners Panel A: Age, Expertise, and Experience Big 4a n ¼ 37 Mean (s.d.) Age in years (n ¼ 167) Years as an audit partner (n ¼ 167) Calculated age at partner (n ¼ 167) # of expert industries (n ¼ 166) Times relocated due to mandatory rotation (n ¼ 166) # of lead partner public-company audits last year (n ¼ 166) # of concurring partner public-company audits last year (n ¼ 166) # of audit partners locally (n ¼ 165) Midsizeb n ¼ 86 Mean (s.d.) Otherc n ¼ 47 Mean (s.d.) Total n ¼ 170 Mean (s.d.) 44.6 (6.9) 9.4 (6.2) 35.2 (3.8) 2.1 (0.9) 0.11 (0.39) 2.1 (1.5) 1.5 (2.2) 21.2 (29.1) 47.8 (8.7) 11.9 (9.4) 35.9 (3.9) 2.8 (1.3) 0.02 (0.15) 2.1 (1.7) 2.5 (3.2) 8.1 (7.3) 46.3 (8.4) 10.2 (9.4) 36.1 (4.9) 2.5 (1.1) 0.02 (0.15) 0.64 (1.43) 0.73 (1.69) 8.4 (6.6) 46.7 (8.3) 10.9 (8.8) 35.8 (4.2) 2.6 (1.2) 0.04 (0.23) 1.7 (1.7) 1.8 (2.8) 11.0 (15.8) Male Total Panel B: Other Demographics Female Gender (n ¼ 166) 20.0% 80.0% 100% Single Married Cohab Divorced Total Personal status (n ¼ 166) Age of children in years (n ¼ 166) 5.4% 0–5 90.4% 6–11 1.8% 12–17 2.4% 18 100% Total Mean # (s.d.) of children by age 0.43 (0.73) Yes 0.57 (0.78) No 0.41 (0.71) Total 0.78 (1.18) 2.14 (1.15) 2.4% 97.6% 100% Big 4a Midsizeb Otherc Total Overall 21.8% 56.1% 50.6% 45.7% 27.6% 40.5% 100% Maintained second residence for client service (n ¼ 167) Firm type (n ¼ 170) Response rate (n ¼ 170) a b c Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers BDO Seidman, Crowe Horwath, Grant Thornton, and McGladrey & Pullen All other firms, primarily top 25 firms not categorized as Big or midsize Auditing: A Journal of Practice & Theory February 2012 46% 106 Daugherty, Dickins, Hatfield, and Higgs averaging around 11 audit partners, with one-third reporting five or fewer partners in their local practice office, and two-thirds having eight or fewer partners (not tabulated), providing a favorable mix of small and midsize practice office locations to investigate the hypotheses The number of audit partners in the local offices of the Big 4, midsize, and other partner respondents average (range) 21 (3–120), (1–45), and (2–30), respectively Direct Effects of Rotation on Audit Quality We first consider partners’ perceptions about the intended benefit of mandatory audit engagement partner rotation (independence) and the generally agreed upon cost (lost client-specific knowledge by the auditors) These relationships are represented by the outside links in the model (Figure 1) Participants were asked the extent of their agreement on a seven-point scale (1— Strongly Disagree, 4—Neutral, 7—Strongly Agree) to statements dealing with rotation It should be noted that p-values are calculated by comparing means to the scale midpoint, which is a meaningful midpoint separating general agreement from disagreement with the survey statement Consistent with H1 (Table 2, Panel A), partners agreed with the statement that such knowledge is lost due to rotation (mean ¼ 5.61; p , 0.01) Further, they perceive that longer auditor tenure increases audit quality (mean ¼ 4.26; p , 0.05) A surveyed partner discussed the importance of client relationship building, a notion that is frequently considered as negative in terms of its potential impact on auditor independence and audit quality, noting: ‘‘It takes several years normally to establish relationships with key executives of an audit client These relationships aid in the partners’ understanding of their client’s businesses which enables them to better identify risk and, as a result, adjust the audit approach to address those risks Therefore, audit quality can be negatively impacted when a key member of the engagement team, who has gained special knowledge of a client, is removed from the team.’’ Consistent with H2 (Table 2, Panel A), partners generally agree with the statements that ‘‘partner rotation improves independence in’’ both fact and appearance (mean ¼ 4.44 and 5.70, respectively; both p-values , 0.001).11 Similarly they agree rotation reduces inappropriate client attachment (mean ¼ 4.69; p , 0.001) Contrary to perceptions regarding the positive impacts of rotation (in general) on auditor independence, our surveyed partners perceive little to no value resulting from accelerating rotation or extending cooling-off periods (Table 2, Panel B) Participants disagree that accelerated rotation (and extended cooling off ) improve independence in fact (means of 2.87 [2.80], with 65.1 [66.3] percent expressing some level of disagreement, and only 13.8 [12.0] percent agreeing, all p-values , 0.001).12 Responding partners also perceive no benefits in terms of extended cooling offs’ impact on independence in appearance (mean of 3.97, p 0.10); however, they believe independence in appearance is enhanced as a result of accelerated rotation (mean of 4.28, 54.5 percent agreeing and 26.4 percent disagreeing, p , 0.05, no differences based on firm size) Effect of Rotation on Partners’ Quality of Life The first link (Link A) in our model demonstrating the indirect effect of rotation on audit quality links partner rotation and partner quality of life H3 predicts rotation, in general, negatively impacts partners’ quality of life Survey results are consistent with this expectation (see Table 3, Panel A) 11 12 Large office partners felt more strongly that partner rotation improves independence in appearance, compared to smaller offices (means of 6.00 and 5.57, respectively, p , 0.05) Larger office partners reported less agreement that the rule changes improved independence in fact, compared to smaller offices (means of 2.50 and 3.10, respectively, p , 0.01) Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 107 TABLE First-Order Effects of Rotation on Audit Quality Panel A: General Rotation Endpoints, Midpoint Statement Client-specific knowledge is lost due to partner rotation Longer partner tenure results in a higher quality audit Partner rotation improves independence in fact (mental attitude) Partner rotation improves appearance of independence Partner rotation reduces the likelihood of inappropriate client attachment 7 7 ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Disagree Agree Disagree Agree Disagree Agree Disagree Agree Disagree Meana (s.d.) Diff from Neutralb 5.61 (1.17) 1.61*** 4.26 (1.56) 0.26* 4.44 (1.52) 0.44*** 5.70 (1.25) 1.70*** 4.69 (1.32) 0.69*** Meana (s.d.) Diff from Neutralb 2.87 (1.41) [1.13]*** 4.28 (1.48) 0.28* 2.80 (1.37) [1.20]*** 3.97 (1.60) [0.03] Agree Panel B: Accelerated Rotation Endpoints, Midpoint Statement Accelerated audit engagement partner rotation requirement improved auditor independence in fact Accelerated audit engagement partner rotation requirement improved auditor independence in appearance Increasing the cooling-off period from years to years before an audit engagement partner can rotate back to a client-improved independence in fact Increasing the cooling-off period from years to years before an audit engagement partner can rotate back to a client-improved independence in appearance 7 ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Disagree Agree Disagree Agree Disagree Agree ¼ Strongly Disagree ¼ Neutral ¼ Strongly Agree *, **, *** Denote significance at , or ¼ 0.05, 0.01, and 0.001 levels, respectively (two-tailed) a The number of responses for the individual statements may be less than the overall number of partners responding (n ¼ 170) due to responses left blank Five or fewer responses were missing for any one question and were unrelated to firm characteristics (e.g., size) b Difference from neutral value of Bracketed difference values indicate disagreement, while non-bracketed values indicate agreement, relative to neutral Auditing: A Journal of Practice & Theory February 2012 Daugherty, Dickins, Hatfield, and Higgs 108 TABLE Perceived Effects of Rotation on Partners’ Quality of Life Panel A: General Rotation Statement Endpoints, Midpoint Rotation increases incoming lead partner workload in first year 7 7 7 Partner rotation increases workload of other audit team members Rotation increases outgoing lead partner workload in first year Audit partner rotation increases the likelihood of relocation in your career The potential for relocation and commuting discourages employees from pursuing an audit partner track Impact on your quality of life if you were to relocate to become lead partner for a new client ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ Strongly Disagree Neutral Strongly Agree Strongly Disagree Neutral Strongly Agree Strongly Disagree Neutral Strongly Agree Very Unlikely Neutral Very Likely Strongly Disagree Neutral Strongly Agree Very Negative Neutral Very Positive Meana (s.d.) Diff from Neutralb 6.14 (0.85) 2.14*** 5.43 (1.14) 1.43*** 4.09 (1.56) 0.09 4.45 (1.81) 0.45** 4.47 (1.52) 0.47*** 2.65 (1.20) [1.35]*** Meana (s.d.) Diff from Neutralb Panel B: Accelerated Rotation Statement Endpoints, Midpoint The change in mandatory audit engagement partner rotation policy from to years significantly increased the frequency you will have to relocate in your career The change in mandatory audit partner rotation policy from to years significantly increased the likelihood you will have to gain new industry expertise during your career The change in the cooling-off period from to years significantly increased the frequency you will have to relocate in your career The change in the cooling-off period from to years significantly increased the likelihood you will have to gain new industry expertise during your career ¼ Strongly Disagree ¼ Neutral ¼ Strongly Agree 4.00 (1.58) 0.00 ¼ Strongly Disagree ¼ Neutral ¼ Strongly Agree 4.70 (1.40) 0.70*** 4.05 (1.51) 0.05 4.73 (1.34) 0.73*** 7 ¼ ¼ ¼ ¼ ¼ ¼ Strongly Neutral Strongly Strongly Neutral Strongly Disagree Agree Disagree Agree *, **, *** Denote significance at , or ¼ 0.05, 0.01, and 0.001 levels, respectively (two-tailed) a The number of responses for the individual statements may be less than the overall number of partners responding (n ¼ 170) due to responses left blank Five or fewer responses were missing for any one question and were unrelated to firm characteristics (e.g., size) b Difference from neutral value of Bracketed difference values indicate disagreement, while non-bracketed values indicate agreement, relative to neutral Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 109 Partners perceive their workload, as well as that of the engagement team, will increase due to rotation (means of 6.14 and 5.43 respectively; both p-values , 0.001) Partners also view mandatory rotation as leading to an increased likelihood of relocating (mean of 4.45, p , 0.01).13 Partners’ Behavioral Response to Rotation Next, we consider H4 (Link B in the model), which predicts, based on quality-of-life concerns, that partners will likely change their behavior in response to rotation To consider this link, we look first at how satisfaction is affected by potential responses to rotation As shown in Table 4, survey respondents indicate that relocating will have a significant and negative impact on partner satisfaction (mean of 2.21, p , 0.001) Similarly, serving less prestigious clients reduces partners’ satisfaction (mean of 2.98, p , 0.001) Note, however, partners are generally neutral (neither satisfied nor dissatisfied) when asked about gaining new industry expertise to deal with rotation (mean of 3.86, not significantly different from neutral) Consistent with H4, multiple mean comparisons (not tabulated) indicate, based on relative satisfaction, they would rather retrain than serve less prestigious clients (p , 0.001), and would rather retrain or serve less prestigious clients than relocate (p , 0.001).14 In addition, when asked specifically how accelerated rotation (longer cooling-off period) would affect the likelihood of their future actions, partners believed only the likelihood of having to learn a new industry would significantly increase (means of 4.70 [4.73], respectively, p-values , 0.001; see Table 3, Panel B) Respondents were neutral regarding the likelihood of relocation (means of 4.00 [4.05], respectively) In spite of concerns expressed by interviewed partners regarding rotation’s impact on the willingness of employees to pursue careers as partners, as depicted in Table 5, our surveyed partners disagree that rotation requirements hinder their ability to attract the best and brightest employees (mean of 3.62, 45 percent expressing some level of disagreement and only 24.3 percent expressing some level of agreement, p , 0.001, no differences based on firm size), and are neutral (mean of 3.98, not significantly different than neutral, no differences based on firm size) on the influence that rotation has on their ability to retain their highest performing employees Finding no increase in expected relocations due to accelerated rotation and lengthened coolingoff rules, discussed above, seems inconsistent with our expectations However, when considered in the overall pattern of results, it is consistent with partners’ anticipated responses to rotation (i.e., retraining rather than relocating or leaving the firm) Consider also partners’ most recent choices, demonstrated in the demographic data reported in Table 1, which shows fewer than four percent of surveyed partners have relocated due to mandatory partner rotation requirements In contrast, 51 percent (not tabulated) reported having learned a new industry due to rotation requirements Together, these findings are consistent with our expectation regarding partners’ responses to mandatory rotation Effect of Relocating versus Retraining on Audit Quality Next we look at perceptions of how different partner actions (i.e., potential responses to accelerated rotation) influence audit quality (Link C) Consistent with H5, partners perceive that when partners retrain to gain new industry expertise, audit quality decreases (mean of 4.36, p , 0.001; Table 5); and they disagree that relocation has a negative effect on audit quality (mean of 13 14 Concerns about the likelihood of relocations were higher for partners of larger firms (means of 5.64 for Big 4, 4.52 for midsize, and 3.43 for other, respectively, p , 0.001) More specific but consistent insights were provided in partner comments For example, one partner noted, ‘‘Relocation with a family is a large disruption to quality of life.’’ Interestingly, several reported health concerns particular to commuting Auditing: A Journal of Practice & Theory February 2012 Daugherty, Dickins, Hatfield, and Higgs 110 TABLE Partners’ Behavioral Response to Rotation Statement Endpoints, Midpoint Satisfaction if asked to relocate because a client with your industry expertise unavailable locally Satisfaction if asked to service a less prestigious client locally if an equally prestigious client not local upon rotation Satisfaction if asked to gain new industry expertise upon rotation if client with your industry expertise not local 7 ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ Very Unsatisfied Neutral Very Satisfied Very Unsatisfied Neutral Very Satisfied Very Unsatisfied Neutral Very Satisfied Meana (s.d.) Diff from Neutralb 2.21 (1.12) [1.79]*** 2.98 (1.20) [1.02]*** 3.86 (1.40) [0.14] *, **, *** Denote significance at , or ¼ 0.05, 0.01, and 0.001 levels, respectively (two-tailed) a The number of responses for the individual statements may be less than the overall number of partners responding (n ¼ 170) due to responses left blank Five or fewer responses were missing for any one question and were unrelated to firm characteristics (e.g., size) b Difference from neutral value of Bracketed difference values indicate increases, while non-bracketed values indicate decreases, relative to neutral TABLE Perceived Impact on Audit Quality Statement Endpoints, Midpoint When audit engagement partners are required to relocate, audit quality declines 7 7 When audit engagement partners are required to gain new industry expertise, audit quality declines When audit engagement partners are required to telecommute, audit quality declines Audit engagement partner rotation requirements hinder an audit firm’s ability to attract the best and brightest employees Audit engagement partner rotation requirements hinder an audit firm’s ability to retain the best and brightest employees ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ ¼ Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Strongly Neutral Strongly Disagree Agree Disagree Agree Disagree Agree Disagree Agree Disagree Meana (s.d.) Diff from Neutralb 3.73 (1.24) [0.27]** 4.36 (1.34) 0.36*** 4.08 (1.35) 0.08 3.62 (1.37) [0.38]*** 3.98 (1.41) [0.02] Agree *, **, *** Denote significance at , or ¼ 0.05, 0.01, and 0.001 levels, respectively (two-tailed) a The number of responses for the individual statements may be less than the overall number of partners responding (n ¼ 170) due to responses left blank Five or fewer responses were missing for any one question and were unrelated to firm characteristics (e.g., size) b Difference from neutral value of Bracketed difference values indicate disagreement, while non-bracketed values indicate agreement, relative to neutral Auditing: A Journal of Practice & Theory February 2012 An Examination of Partner Perceptions of Partner Rotation 111 3.73, p , 0.01).15 Comments from surveyed partners confirm their concerns about the impact of rotation on auditor expertise For example, one partner stated, ‘‘My biggest issue with the current rotation issue relates to the need to completely learn a new industry and clients to which we have little familiarity and industry knowledge.’’ Another viewed a cost of partner rotation as ‘‘a loss of industry knowledge that goes against the intent of the new risk assessment standards [designed] to gain an enhanced understanding of clients’ business.’’ Also consistent with this concern, one partner stated, ‘‘Learning new industries as a partner is not good for the partner or the profession.’’ How Long Will Audit Quality Be Affected? Consistent with the findings of Johnson et al (2002), surveyed partners reported an average (s.d.) of 2.54 (0.73) years to become fully effective on a new audit assignment Fifty-eight percent reported needing more than two years to become fully effective, and 93 percent reported needing at least two years, results not varying significantly by firm size (p 0.50) Comments from surveyed partners addressing the issue included, ‘‘Overall, I believe it takes at least three years for an audit partner to become intimately familiar with a new client, and the five-year rotation requirement actually reduces the quality of the audit.’’ Another said new partners are not initially fully effective, even within the same industry line, because of differing information technology and other processing systems, client personnel, corporate governance characteristics (especially the strength and expertise of the audit committee), and the time it takes to gain client trust at the senior management and board levels CONCLUSIONS AND SUGGESTIONS FOR FUTURE RESEARCH Our findings shed further light on the perceptions of benefits and detriments from differing partner rotation requirements As reported by one of our interviewed partners, ‘‘market participants are only seeing the ‘tip of the iceberg,’ believing the impending rotation cycles will really begin to tell the tale of the impact of the changes on partners’ quality of life and, in turn, on audit quality.’’ Partner perceptions of the direct effects of partner rotation are consistent with prior theory and the result of prior research Specifically, rotation improves independence resulting in a positive impact on audit quality, while the reduced client-specific knowledge is perceived to negatively reduce audit quality A key aspect of this study (and a key concern raised by all of the interviewed partners) is the potential indirect and unintended effects due to partners’ quality of life being impacted by regulations, and how partners manage their career and personal life while operating under the revised regulations Results suggest that partners believe audit quality is maintained by relocating to maintain industry expertise, but perceive audit quality suffers when partners opt to gain new industry experience in order to avoid relocation However, due to quality-of-life issues, partners report being more likely to opt to retrain rather than relocate That is, the preferred response to rotation (if necessary) is to choose an option that they perceive to have a negative effect on audit quality in order to preserve their perceived quality of life Additional results show that partners perceive a two- to three-year new client familiarization period before they are fully effective on new engagements, increasing the amount of time audit engagements suffer from ‘‘start-up’’ efficacy concerns This study has implications for future research, as well as for regulators both within and outside of the U.S For example, Canada and Taiwan adopted similar five-year partner rotation periods 15 Partners from large offices believe relocation has a less negative impact on audit quality, compared to partners from smaller offices (means of 3.12 and 3.86, respectively, p , 0.01), confirming concerns of ACAP and suggesting smaller office locations may be particularly at risk related to potential negative impacts of mandatory rotation Auditing: A Journal of Practice & Theory February 2012 Daugherty, Dickins, Hatfield, and Higgs 112 beginning in 2004; but in 2010, Canada reversed this precedent changing to a seven-year-on, five-year-off policy (see CA 2010) In addition, the International Federation of Accountants may consider accelerating its current seven-year rotation requirement, as U.S and international parties continue in their efforts to converge U.S and international standards Currently there is disparity in various regimes regarding mandatory partner rotation as the European Union requires partner rotation every seven years and a cooling-off period of two years, the U.K has a five-year-on, five-year-off policy, and Australia has a five-year-on, two-year-off policy Care should be taken when drawing inferences from these results, as this study reports only the perceptions of audit partners As such, causality implied by the model cannot be tested with this data Additionally, the survey was quite long and may have resulted in respondent fatigue However, comments from supervising partners as well as written comments on the survey suggest that respondents took the task quite seriously (note also the high response rate) Further, given partners’ general dislike of accelerated rotation and extended cooling off, the data could suffer from demand effects due to general partner bias We attempted to counter this somewhat by starting the survey with the more positive aspects of rotation Overall, such data provide a starting point to understanding the proposed model, and better understanding the intended and unintended effects of rotation regulations For example, partners indicate they think these effects may be magnified for office locations with fewer partners Consistent with this idea, the PCAOB (2007, 6) has noted through the inspection process ‘‘a number of GAAS deficiencies for smaller auditing firms arose from a lack of sufficient industry expertise.’’ Future research can more directly test how office size may moderate the proposed relationship of rotation on audit quality REFERENCES Bamber, E M., and V M Iyer 2007 Auditors’ identification with their clients and its effect on auditors’ objectivity Auditing: A Journal of Practice & Theory 26 (2): 1–24 Beasley, M S., J V Carcello, D R Hermanson, and T L Neal 2009 The audit committee oversight process Contemporary Accounting Research 26 (1): 65–122 Bernardi, R A 2003 A theoretical model for the relationship among: stress, locus of control, and longevity Business Forum 26 (3/4): 27–33 Blouin, J., B M Grein, and B R Rountree 2007 An analysis of forced auditor change: The case of former Arthur Andersen clients The Accounting Review 82 (3): 621–650 Brazel, J F., T D Carpenter, and J G Jenkins 2010 Auditors’ use of brainstorming in the consideration of fraud: Reports from the field The Accounting Review 85 (4): 1273–1301 Bruggemann, U., J M Hitz, and T Sellhorn 2010 Intended and Unintended Consequences of Mandatory ă IFRS Adoption: Review of Extant Evidence and Suggestions for Future Research Working paper, Lancaster University Cameran, M., A Prencipe, and M Trombetta 2009 Auditor Tenure and Auditor Change: Does Mandatory Auditor Rotation Really Improve Audit Quality? 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Trombetta 2009 Auditor Tenure and Auditor Change: Does Mandatory Auditor Rotation Really Improve Audit Quality? Proceedings of the AAA Annual Meeting, New York, NY, and the Fifteenth Annual International