This analysis reveals how mandatory audit firm rotation alters investment efficiency, suggesting significant effects of auditor decisions on corporate strategies.
SUMMARY We investigate how mandatory audit firm rotation (MAR) affects corporate investment efficiency. We develop a framework consisting of an auditor, a company, and an investor. The auditor makes two decisions: her attestation decision takes the form of conservatism or aggressiveness, and her choice of audit evidence precision varies across those two types of attestation. We demonstrate how the capital market price set by the investor reacts to the audited financial report and how the anticipation of the price reaction influences the company’s investment decision. We apply this framework to shed light on the effects of MAR on corporate investment efficiency. We find that (1) when MAR induces a change from auditor aggressiveness to auditor conservatism, it impairs investment efficiency for companies with good investment prospects, (2) when auditor conservatism is in place, MAR impairs investment efficiency for all companies, and (3) in all other cases, MAR improves investment efficiency. JEL Classifications: M42; M48.
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Lu et al. (2025) studied this question.
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