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ABSTRACT
Critics of the auditing profession have often suggested a policy of mandatory rotation of audit firms as a way of countering their perception that long-term relationships between auditors and their clients impede the independence and professional skepticism of the auditors. The American Institute of Certified Public Accountants (AICPA) has maintained that mandatory rotation would be expensive and would, in fact, increase the number of audit and financial reporting failures. Preliminary evidence suggests that neither side has compelling evidence to support its position. Although there are data constraints in estimating audit failure rates, the data imply that the rate of failure is actually much lower in long-term relationships, suggesting there may be no systematic problem to correct. On the other hand, the AICPA's argument that rotation would increase audit failures rests on an assumption that does not appear to be supported by the data.
BACKGROUND
The threat of mandatory auditor rotation is not new to the accounting profession, dating back at least to the hearings surrounding the McKesson Robbins case in the late 1930s. Rotation was a major issue nearly twenty years ago after the Metcalf report [U.S. Senate, 1976] criticized the level of competition in the auditing profession and recommended mandatory rotation. The accounting profession's response, in a report by the Cohen Commission [AICPA, 1978], was to point out the costs of rotation and to suggest, instead, rotation of audit personnel and partners. Most recently, the U. S. Senate Commerce Committee [Journal of Accountancy, 1995] considered a bill in 1994 that would have required rotation of auditors of certain telecommunication companies. This bill also would have required state commissions to appoint the auditors. Hoyle [1978] provides a good discussion of the basic arguments for and against rotation. The basic issues have not changed much since then.
The debate has, however, become an international issue with both Spain and Italy experimenting with mandatory rotation policies.1 Additionally, critics of the accounting profession in Germany and the United Kingdom have called for mandatory rotation of auditors. For example, in the U. K., the McFarlane report suggested auditor appointment periods of only five years and in Germany, Bundesbank adopted rotation to encourage other German companies to do the same [European Accountant, 1996].
Two opposing arguments...