Research Report
The effects of audit firm rotation on perceived auditor independence
and audit quality
Bobbie W. Daniels
a,
⇑
, Quinton Booker
b
a
Jackson State University, College of Business, P.O. Box 17970, Jackson, MS 39217-06700, United States
b
Professor and Chairman, Department of Accounting, Jackson State University, MS, United States
article info
Article history:
Available online 17 April 2011
Keywords:
Audit firms’ independence
Mandatory firm rotation
Audit quality
abstract
Our study explores loan officers’ perceptions of auditors’ independence and audit quality
under three experimental audit firm rotation scenarios. We use a case experiment with
a between-subjects design to determine whether rotation of the audit firm impacts finan-
cial statement users’ perceptions of auditor’s independence and quality. Findings based on
212 useable responses indicate that loan officers do perceive an increase in independence
when the company follows an audit firm rotation policy. However, the length of auditor
tenure within rotation fails to significantly change loan officers’ perceptions of indepen-
dence. Findings also indicate that neither the presence of a rotation policy nor the length
of the auditor tenure within rotation significantly influences the loan officers’ perceptions
of audit quality.
Published by Elsevier Ltd.

quality. DeAngelo (1981b) defines audit quality on two
dimensions: the market-assessed joint probability that
auditors will discover a breach in the client’s accounting
system; and the likelihood an observed breach will be re-
ported. DeAngelo reasons that an auditor who has an eco-
nomic interest in their client or lacks auditor independence
will be less likely to report a discovered breach, thus reduc-
ing audit quality (DeAngelo, 1981a).
The AICPA issued a report, ‘‘Statement of Position
Regarding Mandatory Rotation of Audit Firms of Publicly
1052-0457/$ - see front matter Published by Elsevier Ltd.
doi:10.1016/j.racreg.2011.03.008
⇑
Corresponding author.
E-mail address: [email protected] (B.W. Daniels).
Research in Accounting Regulation 23 (2011) 78–82
Contents lists available at ScienceDirect
Research in Accounting Regulation
journal homepage: www.elsevier.com/locate/racreg
Held Companies’’ in 1992. The AICPA opposed mandatory
rotation citing that mandatory audit firm rotation was
not in the best interest of the public. According to this
study, the AICPA examined 400 cases of audit failures be-
tween 1979 and 1991 and found that audit failures were
about three times more likely when the auditor was per-
forming the first or second audit of that company. The
study asserts that requiring firms to change auditors would
increase the risk of audit failures because auditors would
not have sufficient knowledge of the client’s business,
which is important to identify problems early in a business

rotation (using different audit firms). GAO also interviewed
other interested parties (consumer groups, institutional
investors, accountants, etc.). Views of these groups were
consistent with the overall views of other survey respon-
dents interviewed by GAO. GAO acknowledges that it will
take several years of experience with the implementation
of SOX before the effectiveness of the act can be fully as-
sessed (GAO, 2003).
Research questions
This study addresses two research questions. First, we
address whether periodic rotation of the external audit
firms would affect bank loan officers’ perceptions of exter-
nal auditor independence. While this topic has been stud-
ied, the answer remains unclear. Numerous researchers
have addressed this topic by using accruals-based mea-
surements, (Myers, Myers, & Omer, 2003), earning man-
agement tools (Ghosh & Moon, 2005), financial reporting
failures (Carcello & Nagy, 2004) and Judges’ perceptions
(Jennings, Pany, & Reckers, 2006). Some researchers have
argued that audit firm rotation appears to increase the per-
ception of auditor independence (Arel, Brody, & Pany,
2005; Brody & Moscove, 1998; Jennings et al., 2006; Kemp,
Reckers, & Arrington, 1983; Ramsey, 2001; Winters, 1978;
Wolf, Tackett, & Claypool, 1999). However, because there
are no regulatory requirement for audit firm rotation and
99% of the fortune 1000 public companies do not have a
policy that requires audit firm rotation (GOA, 2003), archi-
val data is not available for research in this area. Our exper-
imental design circumvents the endogeneity problem. We
do so by using an experimental design that manipulates (1)

ceptions of audit quality?
Research methods
We use a between-subjects experimental design for this
research with three versions of a case. The versions of the
case are different only as it relates to the rotation policy
and length of tenure within the rotation policy. This sec-
tion provides details on participants, data gathering and
variables, and statistical methods.
Participants
Our population consists of one thousand bank loan offi-
cers who were randomly selected from a database of more
than 16,000 U.S. bank loan officers. We randomly assigned
the loan officers to one of three versions of the research
B.W. Daniels, Q. Booker / Research in Accounting Regulation 23 (2011) 78–82
79
instrument. We received 207 useable responses, represent-
ing a response rate of 24.07%. The 207 responses are evenly
distributes among the three experimental groups. Five
respondents who failed the manipulation checks were re-
moved from our analyses. The participants are comprised
primarily of executives (77.9% – president or vice presi-
dents). In addition, participants are mostly college edu-
cated with 77% having baccalaureate degrees or higher.
Finally, participants have significant experience, with 87%
having over 10 years of banking experience and 67% having
10 years or more of bank lending experience.
Data gathering and variables
Each of the three experimental scenarios used involves
a company’s audit firm rotation policy. The focus of the
case is a material error in the pre-audit financial state-

for differences among all possible combinations of groups,
and chi-square analysis to compare proportions of ‘‘Yes’’
and ‘‘No’’ responses to the question concerning whether
the audit firm should be allowed to do the audit. This
dichotomous response question is designed to have the
participant make a firm decision based on the perceived-
level of independence recorded for the first question.
Results
The first research question asks whether the presence of
an audit firm rotation policy impacts bank loan officers’
perceptions of auditor’s independence and quality. The re-
sults are summarized in Table 1. ANOVA results for ques-
tion Q1a indicate that the perceptions of auditor
independence are significantly different among the three
groups (F = 4.476, p < .05). These results suggest that
respondents’ perceptions are influenced by the presence
of an audit rotation policy.
To compare the three groups, we use Scheffe Tests of
Multiple Comparisons. The rotation groups are perceived
as having a significantly higher level of auditor indepen-
dence than the no rotation group (p < .05). The mean re-
sponse of AFR0 is 5.65 and mean response for AFR1 and
AFR6 are 6.70 and 6.77, respectively. Thus, a significant dif-
ference in perceptions exists between a firm that has a
rotation policy and one that does not. These results suggest
that loan officers are more confident that the external CPA
firm is independent when a rotation policy is present. The
Table 1
Bank loan officers’ perceptions of auditor independence and quality.
Group Independence

means for AFR1 and AFR6 do not differ significantly. Thus,
findings fail to indicate a significant difference in percep-
tion of auditor independence when the firm is performing
the audit in the first year of a rotation policy versus in sixth
year of a rotation policy.
The second research question asks whether the pres-
ence of an audit firm rotation policy impacts bank loan
officers’ perceptions of audit quality (Q2a) and the impact,
if any, of the length of the auditor tenure within rotation
(Q2b). Results reveal no significant differences in loan offi-
cers’ confidence that the auditors would discover the
inventory error in the financial statements. The statistical
findings suggest that the presence of a rotation policy or
the length of the auditor-tenure within rotation does not
influence the respondents’ perception of the auditors dis-
covering errors in the financial statement. Finally, the rota-
tion policy did not significantly affect the beliefs of the loan
officers regarding whether the audit firm would report the
error in its opinion.
In summary, the perceptions of loan officers relative to
discovering errors in the financial statement are only
slightly modified when a company employs the same audit
firm as compared to rotating their audit firms. Further-
more, the length of the auditor tenure within a rotation
policy fails to significantly change the loan officers’ percep-
tions of audit quality.
Conclusions, limitation, and future research
Loan officers’ perceive that the presence of an audit firm
rotation policy enhances the perceptions of auditor inde-
pendence, but does not enhance perceptions of audit qual-

audit rotation.
Future research could explore whether user groups
views are differ from loan officers (e.g. financial analysts,
investors, fund managers, audit committee members,
etc.). The AICPA (2006) published a document containing
safeguards to mitigate or eliminate threats to indepen-
dence. Research is needed regarding the effectiveness of
different safeguards in different situations. Other scenarios
involving various lengths of time for the rotation period
could also be explored, such as a 3-year, 5-year or 10-year
rotation period.
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