Mandatory Audit Firm Rotation – a Literature Review Essay example

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Mandatory Audit Firm Rotation – A Literature Review

Since the passing of the Sarbanes-Oxley Act of 2002, much debate has occurred concerning mandatory auditor rotation for publicly held companies. Most corporate scandal involves dishonest or questionable accounting. This realization has brought about the priority to take more measures are taken to assure companies disclose the most reliable financial information. It is believed that a lack of auditor independence may be to blame for fraud as we have seen in recent years. The Sarbanes-Oxley Act of 2002 ordered an investigation of whether or not implementation of a mandatory auditor rotation policy could be beneficial. If this were to take effect it would require that
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Earnings Quality
There are several things that have been researched with regard to effect on earnings quality. Quite a few studies have been conducted to determine if there is a correlation between auditor specialization, auditor tenure and earnings quality. First, research has shown that high quality auditors tend to be linked to better earnings quality. This is because high quality auditors are believed to use a high amount of prudence in their audits as well as having high client retention (Gul, 2009).
Some of the research concerning auditor tenure has shown that companies have a lower amount of discretionary accruals and that investor perception of quality is higher with longer auditor tenure, in which both are positively linked to better earnings quality. This appears to show that lengthier auditor tenure will result in lower likelihood that management will use accruals to make earnings look better (Gul, 2009).
Other research aligns with “learning theory of psychology” stating that auditors need to have time to build knowledge of the industry and business of their clients in order to achieve effective audits. In effect, the expertise within an industry allows auditors to efficiently detect errors or misrepresentations in the financials of their clients. This