Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

July 12, 2013 Leave a comment

Departing and Incoming Auditor Incentives, and Auditor-Client Misalignment under Mandatory Auditor Rotation: Evidence from Korea

Gil S. Bae Korea University – Department of Accounting

Sanjay Kallapur Indian School of Business

Joon Hwa Rho Chungnam National University – College of Business

June 18, 2013

Abstract: 
In this paper we provide evidence on specific factors that could affect audit quality under mandatory rotation, using data from Korea where mandatory auditor rotation was put into effect in 2006. We find no evidence supporting the “Brillo pad effect” (the argument that departing auditors have incentives to clean up the balance sheet) or the “new broom effect” (the argument that new auditors can find problems that long-standing auditors tend to overlook). On the contrary, departing auditors spend fewer hours just before rotation, consistent with a lack of incentives to maintain quality given the impending rotation. Compared to clients in other mandatory rotations, the clients rotating away from industry specialist auditors have higher audit hours and higher absolute discretionary accruals post-rotation, suggesting there are adverse effects from breaking such auditor-client pairings. Finally we find that Big 4 auditors’ market share continues to increase after mandatory rotation is imposed. Our findings therefore fail to support mandatory rotation.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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