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discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/228306340
Mandatory Audit-Partner Rotation, Audit Quality

and Market Perception: Evidence from Taiwan
ARTICLE in SSRN ELECTRONIC JOURNAL APRIL 2005
DOI: 10.2139/ssrn.717421
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Wuchun Chi
Huichi Huang
National Chengchi University
Oregon State University
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Hong Xie
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Mandatory Audit-Partner Rotation, Audit Quality and Market Perception:

Evidence from Taiwan
Wuchun Chi
Department of Accounting
Taipei, Taiwan
Huichi Huang
National Taiwan University
Taipei, Taiwan
Yichun Liao
Taipei, Taiwan
Hong Xie*
Department of Accountancy
University of Illinois at Urbana-Champaign
Champaign, IL 61820
April 2005
*Corresponding author. Department of Accountancy, University of Illinois at Urbana-Champaign, 1206

South Sixth Street, Champaign, IL, USA. Email: hongxie@uiuc.edu. Phone: (217) 244-4608. Fax: (217)
244-0902. We thank Chan-Jane Lin, James Myers, Ira Solomon, Theodore Sougiannis and workshop
participants at National Chengchi University and National Taipei University for help, comments and
suggestions. Professor Chi gratefully acknowledges the financial support from National Science Council
(Project No. NSC 93-2416-H-004-036).

Abstract:
We examine the effectiveness of mandatory audit-partner rotation in promoting
audit quality using audit data in Taiwan where a five-year audit-partner rotation became
de facto mandatory in 2004. Using both absolute and signed abnormal accruals and
abnormal working capital accruals as proxies for audit quality, we find some evidence
that audit quality of companies subject to mandatory audit-partner rotation in 2004 is
higher than audit quality of companies not subject to rotation in 2004. However, audit
quality of companies subject to mandatory rotation in 2004 is lower than audit quality of
these same companies in 2003 under the old audit partners. Furthermore, audit quality of
companies subject to mandatory rotation in 2004 is indistinguishable from audit quality
of companies whose audit partners were voluntarily rotated before 2003. Therefore, our
early evidence suggests that the effect of mandatory audit-partner rotation on audit
quality, in terms of auditors constraining managements extreme income-increasing or
extreme income-decreasing accruals, is mixed. In contrast, using earnings response
coefficients as a proxy for investor perceptions of audit quality, we consistently find that
investors perceive mandatory audit-partner rotation as enhancing audit quality,
suggesting that mandatory audit-partner rotation enhances auditor independence in
appearance.
Keywords Mandatory audit-partner rotation; Auditor-tenure; Audit quality; Perceptions
of audit quality

1. Introduction
Recent failures in corporate financial reporting, such as the collapses of Enron,
WorldCom and other major corporations, have eroded the publics confidence in audited
financial statements and rekindled a national debate on auditor independence and audit
quality. During the debate, mandatory audit-firm rotation and mandatory audit-partner
rotation, which set a limit on the period of years an audit firm and audit partner,
respectively, may audit a particular companys financial statements, are often proposed as
a means to enhance auditor independence and audit quality. These proposals are based on
the assumption that extended audit-firm or audit-partner tenure can impair auditor
independence and thus setting a limit on audit-firm or audit-partner tenure would improve
audit quality. Reflecting such an assumption, the Sarbanes-Oxley Act of 2002 (hereafter,
the SOX Act) mandates a five-year rotation for the lead and concurring audit partners.1
While audit-partner rotation is not new in the U.S. audit market since American Institute
of Certified Public Accountants (AICPA) has long required that audit partners in charge
of SEC audit engagements be rotated at least once every seven years, the SOX Act,
nevertheless, shortens the audit-partner rotation period in the U.S. from seven to five
years with the intent to enhance auditor independence and audit quality.
Mandatory audit-firm rotation was also considered during the congressional hearings before the SOX Act,
but was not included in the act. Congress decided that mandatory audit-firm rotation needed further study
and required the GAO to study the potential effects of mandatory audit-firm rotation within one year of the
passage of the SOX Act. The ensuing GAO (2003) report concludes that the potential benefits of
mandatory audit firm rotation are harder to predict and quantify, though we are fairly certain that there will
be additional costs (p. 8) and that the most prudent course at this time is for the SEC and the PCAOB to
monitor and evaluate the effectiveness of the acts requirements to determine whether further revisions,
including mandatory audit firm rotation, may be needed to enhance auditor independence and audit quality
to protect the public interest (p. 5).
Although mandatory audit-partner rotation has existed in the U.S. for some time
and is recently strengthened by the SOX Act to enhance audit quality, the efficacy of
mandatory audit-partner rotation in promoting audit quality has not been systematically
investigated. One roadblock has been that U.S. audit reports contain the names of audit
firms, but not audit partners, i.e., information about audit-partner tenure and audit-partner
rotation is not publicly available in the U.S. Consequently, researchers only have been
able to identify auditor tenure at the audit-firm level but not at the audit-partner level
using public data. This limits their ability to directly examine the effect of mandatory
audit-partner rotation on audit quality. For example, recent studies using U.S. data find
that audit quality or financial reporting quality, as measured by absolute and signed
abnormal accruals and accrual persistence, increases with audit-firm tenure (Johnson,
Khurana and Reynolds 2002; Myers, Myers and Omer 2003). These studies, however, do
not speak directly to the relation between mandatory audit-partner rotation and audit
quality because they identify auditor tenure at the audit-firm level.
Unlike the U.S., audit reports in Taiwan contain both audit-firm names and auditpartner names. Exploiting this institutional feature in Taiwan, Chen, Lin and Lin (2004)
examine the relation between audit-partner tenure and earnings quality. They find a
negative relation between absolute abnormal accruals and audit-partner tenure, consistent
with findings in the U.S. based on audit-firm tenure.2 However, their sample period is
between 1990 and 2001 when audit-partner rotation in Taiwan was voluntary. Since the
incentives and behavior of audit partners may change significantly under a mandatory
Chen et al. (2004) also regress absolute abnormal accruals on both audit-partner tenure and audit-firm
tenure. They find that audit-firm tenure is not significantly related to absolute abnormal accruals in the
presence of audit-partner tenure while audit-partner tenure remains significantly negatively related to
absolute abnormal accruals in the presence of audit-firm tenure.
rotation regime, their findings cannot be generalized to the current mandatory auditpartner rotation regime in Taiwan. In short, the extant literature has not investigated the
relation between mandatory audit-partner rotation and audit quality and has not tested the
validity of the implicit assumption in the SOX Act that mandatory audit-partner rotation
enhances audit quality.
In this paper, we investigate the effectiveness of mandatory audit-partner rotation
in promoting audit quality using Taiwanese data. Inspired by the SOX Act in the U.S.,
two main stock exchanges in Taiwan, Taiwan Stock Exchange Corporation (TSEC) and
Gretai Securities Market (GTSM), adopted a set of rules in April 2003 that, in effect,
require a five-year mandatory audit-partner rotation for all listed companies in Taiwan.3
These rules became fully effective in 2004 for both semi-annual and annual reports with
2003 as a transition period (more details below). We use the 2004 semi-annual reports of
listed Taiwanese companies in the Taiwan Economic Journal (TEJ) database for this
study. Semi-annual reports in Taiwan are audited just like annual reports and the 2004
semi-annual reports are the first set of data that reflect the full force of the mandatory
audit-partner rotation requirement in Taiwan as of the time of this study.
Following prior studies, we use both absolute and signed abnormal accruals and
abnormal working capital accruals as proxies for audit quality (e.g., Myers et al. 2003).
We identify a sample of companies whose audit-partners were rotated in 2004 within the
same audit firm due to the mandatory audit-partner rotation requirement. We compare
our mandatory rotation sample with three benchmarks to examine the effect of mandatory
audit-partner rotation on audit quality. First, we compare the mandatory rotation sample
with companies in 2004 whose audit-partners were not required to rotate. We find that
3
TSEC and GTSM in Taiwan are analogous to NYSE and NASDAQ in the U.S.
absolute abnormal working capital accruals are smaller (and thus audit quality higher) for
the mandatory rotation sample relative to the non-rotation sample after controlling for
company age, size, industry growth, cash flows and auditor type (Big 4 versus non-Big
4). For signed abnormal accruals and signed abnormal working capital accruals, we find
that positive (negative) accruals are generally less extremely positive (negative) for the
mandatory rotation sample relative to the non-rotation sample. We, thus, find that audit
quality of the mandatory rotation sample is higher than audit quality of the non-rotation
sample.4
Second, we compare companies in our mandatory rotation sample in 2004 to
themselves in 2003. We find that audit quality in the rotation year under the new audit
partners is lower than audit quality one year ago under the old audit partners.5
Third, we compare our mandatory rotation sample with companies in years before
2003 whose audit-partners were voluntarily rotated within the same audit firm. Our
purpose is to examine whether there is an incremental effect of mandatory audit-partner
rotation relative to voluntary audit-partner rotation that audit firms themselves may
institute internally. We consistently find that audit quality of our mandatory rotation
sample is statistically indistinguishable from audit quality of the voluntary rotation
sample, regardless of whether audit quality is measured in terms of absolute or signed
abnormal accruals and abnormal working capital accruals.
In addition to the above accounting-based proxies for audit quality, prior studies
also use market-based proxies, such as the earnings response coefficient (ERC), for
As explained in more details below, based on prior studies (e.g., Myers et al. 2003), audit quality of a
company is said higher if abnormal accruals or abnormal working capital accruals of that company are less
extreme (i.e., smaller in absolute value and less extremely positive or less extremely negative).
5
The first and second findings appear contradictory. We offer an explanation in Section 4.1.
investor perceptions of audit quality (e.g., Teoh and Wong 1993; Ghosh and Moon 2005).
Following this line of research, we use ERC estimated from contemporaneous returnsearnings regressions to examine whether mandatory audit-partner rotation enhances
investor perceptions of audit quality. After controlling for company age, auditor type,
growth, earnings persistence, earnings volatility, systematic risk, size and financial
leverage, we find that ERC is higher for our mandatory audit-partner rotation sample
relative to each of our three benchmark samples: (1) companies in 2004 whose auditpartners were not rotated; (2) companies in the mandatory rotation sample in 2003 when
the old audit partners were not yet rotated off; and (3) companies in years before 2003
whose audit partners were voluntarily rotated within the same audit firm. Thus, we obtain
consistent evidence suggesting that investors perceive mandatory audit-partner rotation as
enhancing audit quality.
This paper contributes to the growing literature on auditor tenure and audit
quality. While prior studies find that audit quality is positively associated with audit-firm
tenure (Johnson et al. 2002; Myers et al. 2003) or audit-partner tenure (Chen, Lin and Lin
2004) under the voluntary audit-firm or audit-partner rotation regime, these findings do
not speak directly to the effectiveness of mandatory audit-partner rotation in promoting
audit quality. To our knowledge, this is the first study to directly examine the effect of
mandatory audit-partner rotation on audit quality. Our findings based on Taiwanese data
have implications for the U.S. audit market. Specifically, our paper seems to imply that
the effectiveness of the mandatory audit-partner rotation clause in the SOX Act in
promoting audit quality, when measured in terms of auditors constraining managements
extreme income-increasing or extreme income-decreasing accruals, may be limited. This
echoes the concern in Francis (2004, p. 359) that the SOX Act was hastily passed without
serious academic inputs. On the other hand, our findings also suggest that investors
perceive mandatory audit-partner rotation as enhancing audit quality, perhaps due to
improved auditor independence in appearance resulting from mandatory audit-partner
rotation. Since perceptions are very important for audit services due to difficulty in
directly observing audit quality, our paper seems to imply that the mandatory auditpartner rotation clause in the SOX Act is of value in restoring investors confidence by
signaling to them that Congress is serious about maintaining auditor independence.
Our findings, however, must be interpreted with caution because they are based
on the first set of semi-annual reports after the mandatory rotation rule in Taiwan. The
effect of mandatory audit-partner rotation on audit quality may take some time to realize.
In addition, our findings only have implications for but may not be generalizable to the
U.S. audit market due to institutional differences between Taiwan and the U.S. We
discuss strengths and limitations of our study in the conclusion section.
The remainder of the paper is organized as follows. Section 2 describes
Taiwanese regulation of mandatory audit-partner rotation and develops hypotheses.
Section 3 describes data and sample selection. We present our empirical models and
findings in Section 4 and conclude in Section 5.
2. Taiwanese Regulation and Hypothesis Development

2.1. Mandatory Audit-Partner Rotation in Taiwan
Unlike the U.S. where audit reports of public companies only show audit-firm
names, audit reports in Taiwan show both audit-firm names and names of two signing
audit partners.6 Again unlike the U.S. where audit-partner rotation every seven years has
been required by AICPA for some time and audit-partner rotation every five years is
mandated in the SOX Act, audit-partner rotation in Taiwan has been entirely voluntary
until 2003.
In April 2003, after the passage of the SOX Act in the U.S., Taiwan Stock
Exchange Corporation (TSEC) and Gretai Securities Market (GTSM), two main stock
exchanges in Taiwan, promulgated two rules that, in effect, require a five-year mandatory
audit-partner rotation. First, both stock exchanges amended their procedures for auditing
the financial statements of listed companies and added a clause stating that if the lead or
concurring audit partner has performed audit services for a public company in each of the
five previous years then that companys financial statements are subject to the stock
exchanges substantive review procedure.7 Substantive review is a procedure instituted
by both exchanges to protect investors interests. Specifically, the stock exchange would
routinely review financial statements of listed companies and conduct checks on their
business and stock transactions. If the stock exchange finds significant irregularities, it
will take appropriate actions (see below). Second, the original texts of the new clause
stipulate that the five-year rule for both lead and concurring audit partners becomes
effective immediately after the promulgation. However, there was a large percentage of
audit firms with two audit partners auditing the same client in the previous four or more
years in Taiwan as of 2003. Taiwan Accountants Union argued that it would be difficult
6
Annual and semi-annual financial statements of listed companies in Taiwan must be audited. Audit
reports are required to be certified by one audit partner and show the name of that audit partner and name
of the audit firm before 1983. Beginning in 1983, audit reports in Taiwan must be certified by two audit
partners and show their names as well as the audit firm name.
7
See Section 4-2-2-4 of Taiwan Stock Exchange Corporation Procedures for Auditing the Financial Report
of Listed Companies and Section 4-2-2-5 of Gretai Securities Market Procedures for Auditing the Financial
Report of Listed Companies.
for audit firms, especially small audit firms, to rotate two audit partners in the same year.
In response to this and other concerns, both stock exchanges changed the effective time
for full implementation of the five-year rotation rule for both audit partners to 2004 with
2003 as a transition period when audit firms are allowed to have one audit partner, but
not both, auditing the same client for more than five years up to 2003.
After a stock exchange determines that a companys financial statements are
subject to substantive review, it will request and review audit working papers from the
audit partners. If the exchange finds any violations of auditing standards or accounting
standards, it will refer the case to relevant government agencies for administrative or
punitive actions according to Certified Accountant Law, Securities and Exchanges Law
and related regulations. According to these relevant laws and regulations in Taiwan,
appropriate punishments range from reprimand to suspension of license or even criminal
charges. Since the potential punishments are severe, these two stock exchanges recent
rules to subject a companys financial statements to substantive review if they are audited
by the same lead or concurring audit partner in the previous five years, in effect, mandate
a five-year audit-partner rotation for both lead and concurring audit partner.
2.2. Literature Review and Hypothesis Development
The separation of ownership and control in public companies creates conflict of
interests between management and outside stakeholders of the companies. Given the
conflict of interests and asymmetric information, financial statements prepared by
management are audited by a third party (an auditor) to mitigate agency costs between
management and outside stakeholders (Dopuch and Simunic 1982; Watts and
Zimmerman 1986). The value of auditing, however, depends on audit quality, which, in
turn, depends on auditor competence and independence. Auditor independence, therefore,

is critically important for the value or perceived value of audit services.
Recent high profile failures in corporate financial reporting has brought to the fore
the issue of auditor independence and audit quality. A recurring debate is whether
extended audit-firm tenure impairs auditor independence and whether mandatory auditfirm rotation enhances audit quality. Proponents of mandatory audit-firm rotation argue
that pressures faced by the incumbent auditor to retain the audit client coupled with the
auditors comfort level with management developed over time can adversely affect
auditor independence and audit quality. For example, Mautz and Sharaf (1961) suggest
that extended auditor tenure could have a negative effect on audit independence because
auditor objectivity is reduced with the passage of time. Farmer, Rittenberg and Trompeter
(1987) find that auditors tend to agree with managers view if their disagreement with
managers would result in loss of clients. Similarly, Brody and Moscove (1998) believe
that mandatory audit-firm rotation helps reduce undue influence from management on
auditors and thus can enhance audit quality.
On the other hand, opponents of mandatory audit-firm rotation believe that
mandatory audit-firm rotation will increase costs incurred by both audit firms and auditee
companies. In addition, they contend that mandatory audit-firm rotation may result in an
increased likelihood of audit failures due to new auditors lack of client-specific
knowledge of risk, operations and financial reporting practices and the time needed to
acquire that knowledge. Consistent with this view, academic research and professional
studies find that audit failures are much more likely to occur in the first one or two years
(Petty and Cuganesan 1996; Geiger and Raghunandan 2002; Carcello and Nagy 2004;
10
AICPA 1992) and that auditor litigation risk is higher in the early years of an engagement
(e.g., Palmrose 1986; 1991).
In addition to small sample studies cited above using audit-report-based proxies
for audit quality (e.g., audit failures, reporting frauds and auditor litigation), recent
studies utilize properties of audited financial statements to examine the relation between
audit-firm tenure and audit quality in large samples. These studies typically use absolute
and signed abnormal accruals estimated using the Jones (1991) model as proxies for audit
quality.8 For example, Johnson et al. (2002) document that short audit-firm tenures of two
to three years are associated with lower-quality financial reporting, as measured by
absolute abnormal accruals and accrual persistence, relative to medium audit-firm tenures
(four to eight years) or long audit-firm tenures (nine or more years). Similarly, Myers et
al. (2003) find a positive relation between audit quality and audit-firm tenure. These
findings are inconsistent with the claim that audit quality deteriorates with prolonged
audit-firm tenure under the current voluntary audit-firm rotation regime.
Recent studies also use market-based measures, such as the cost of debt and
earnings response coefficients, as proxies for investor perceptions of audit quality. For
example, Mansi, Maxwell and Miller (2004) find a significantly negative relation
between the cost of debt and audit-firm tenure, suggesting that audit-firm tenure
enhances, rather than impairs, audit quality. On the other hand, Ghosh and Moon (2005)
use earnings response coefficients estimated from concurrent returns-earnings regressions
8
A main justification for using accrual-based measures as proxies for audit quality is that abnormal
accruals have become an accepted proxy for earnings management and earnings quality in the accounting
literature (e.g., Jones 1991; Healy and Wahlen 1999; Dechow and Dichev 2002) and that audited financial
statements should be viewed as a joint outcome from the audit firm and company management (Antle and
Nalebuff 1991). When audit quality is high, auditors constrain managements extreme income-increasing or
extreme income-decreasing accruals, resulting in reported earnings that are of high quality (Myers et al.
2003).
11
as a proxy for investor perceptions of audit quality (see also, Teoh and Wong 1993) and
document a positive association between investor perceptions of audit quality and auditfirm tenure. Findings using market-based proxies for perceived audit quality, therefore,
are consistent with findings using accounting-based proxies for audit quality.
To summarize, recent calls for mandatory audit-firm rotation have stimulated a
national debate on pros and cons of mandating audit-firm rotation and an emerging
literature on auditor tenure and audit quality. Overall, evidence from academic research
does not support the claim that extended audit-firm tenure impairs audit quality under the
current voluntary audit-firm rotation regime.
In sharp contrast to the debate on mandatory audit-firm rotation, mandatory auditpartner rotation has already existed in the U.S. for some time although the pros and cons
of mandatory audit-firm rotation are applicable to mandatory audit-partner rotation to a
large extent. AICPA requires audit-partner rotation every seven years. The IFAC Report
(2003, p. 33) recommends that the lead and reviewing audit partners be compulsorily
rotated after a period not exceeding seven years. Most significantly, Section 203 of the
SOX Act mandates a five-year rotation for the lead as well as reviewing audit partners.
Implicitly in the AICPA professional requirement, the IFAC recommendation and the
SOX Act is the assumption that mandatory audit-partner rotation enhances audit quality.
However, the validity of such an assumption is not tested in the accounting literature due
to the lack of audit-partner information in U.S. public databases.
Unlike the U.S., audit reports in Taiwan contain both the audit-firm name and two
signing audit-partner names. In addition, audit-partner rotation in Taiwan has been
entirely voluntary until 2003. Starting in 2004, a five-year audit-partner rotation becomes
12
de facto mandatory. The purpose of this study is to investigate the efficacy of mandatory
audit-partner rotation in promoting audit quality using Taiwanese data. Following prior
studies, we use absolute and signed accrual measures as a proxy for audit quality
(Johnson et al. 2002; Myers et al. 2003) and earnings response coefficients as a proxy for
investor perceptions of audit quality (Teoh and Wong 1993; Ghosh and Moon 2005). We
formulate the following two hypotheses (stated in alternative form) based on the implicit
assumption in the SOX Act:
HYPOTHESIS 1. Audit quality of companies whose audit-partners are mandatorily
rotated is higher than audit quality of companies whose audit-partners are
not required to rotate.
HYPOTHESIS 2. Investor perceptions of audit quality of companies whose auditpartners are mandatorily rotated are higher than investor perceptions of
audit quality of companies whose audit-partners are not required to rotate.
3. Sample Selection and Data

Data for this study are collected from the 2004 semi-annual TEJ database for
companies listed on TSEC or GTSM. We identify a sample of companies whose auditpartners (at least one of them) were required to rotate within the same audit firm in 2004
(M-sample) and another sample of companies whose audit-partners (both of them) were
not required to rotate in 2004 (N04-sample) using the following procedure. First, we
identify 1,022 companies in 2002 from the TEJ database after excluding all Taiwan
Depository Receipts (TDR) because semi-annual financial statements of TDRs are only
reviewed rather than audited. We delete 21 companies with missing audit-partner
13
information and 3 companies with a non-calendar fiscal year end. We thus obtain a
preliminary sample of 998 companies in 2002. Second, we trace audit partners of these
998 companies in past years up to 2002, and find 832 companies with at least one audit
partner who had performed audit services for the same client for at least four consecutive
years as of 2002 and 166 companies with both audit partners who had performed audit
services for the same client for less than four consecutive years as of 2002. We classify
the 832 companies identified above into our mandatory rotation sample (M-sample) since
at least one of their audit partners needs to rotate in 2004 and the 166 companies into
non-mandatory rotation sample (N04-sample) since none of their audit partners has to
rotate in 2004.
Third, we trace audit partners of companies in our M-sample and N04-sample to
years 2003-2004 to determine whether audit partners are rotated in 2004. We lose
additional companies for the following reasons in M-sample (N04-sample): (i) 30 (7)
companies due to delisting; (ii) 78 (0) companies due to their changing audit firms during
2003-2004;9 (iii) 109 (0) companies because one of their audit partners was rotated off in
2003 but came back in 2004; (iv) 1 (0) company because both audit partners were rotated
off in 2003 but at least one came back in 2004;10 (v) 15 (0) companies for whom one
audit partner should be rotated in 2004 but was not rotated; (vi) 28 (0) companies for
which both audit partners should be rotated in 2004 but only one audit partner was
9
When companies change audit firms, their audit partners are automatically changed. This kind of auditpartner change is not due to the mandatory rotation requirement and is excluded from our samples. Our
mandatory audit-partner rotation sample contains only audit-partner rotation within the same audit firm.
10
The rotation requirement in Taiwan only forbids audit partners from providing audit services for the
client for five consecutive years with no other clear guidance such as the cooling off period. This ambiguity
provides some companies with an opportunity to circumvent the requirement by rotating audit partners with
at least four consecutive years of audit services as of 2002 off in 2003 and then rotate them back in 2004.
We exclude these companies in our mandatory rotation sample because audit partners who came back in
2004 cannot be considered as new audit partners for their clients as they were rotated off only for one year
in 2003.
14
rotated; (vii) 18 (23) companies in financial industries whose accruals are difficult to
interpret; and (viii) 6 (2) companies for which there are less than eight observations in the
same industry classification in a year since we require at least eight observation to
estimate abnormal accruals for each industry-year combination using the Jones (1991)
model. The above process generates 547 (134) companies in our M-sample and N04sample, respectively. Table 1, panel A, summarizes the sample selection process.
[Insert Table 1 here]
In testing our hypotheses, we compare our mandatory rotation sample (M-sample)
with three benchmark samples. The first benchmark sample consists of companies in
2004 whose audit partners were not required to rotate, i.e., N04-sample described above.
Our purpose is to examine whether audit quality of the mandatory rotation sample is
higher than audit quality of the non-rotation sample. The second benchmark sample
consists of the same 547 companies in our M-sample when their old audit partners were
not yet required to rotate in 2003 (N03-sample). Our purpose is to examine whether audit
quality of the mandatory rotation sample in 2004 under the new audit partners is higher
than audit quality one year ago under the old audit partners. The third benchmark sample
consists of companies in years before 2003 whose audit-partners (at least one of them)
were voluntarily rotated within the same audit firm (VAP-sample). Our purpose is to
examine whether audit quality of the mandatory rotation sample is higher than audit
quality of companies who voluntarily rotated their audit partners before 2003.
The sample selection process for our VAP-sample is summarized in panel B,
Table 1. Specifically, we identify companies in 2002 and earlier years for which at least
one of audit partners was voluntarily rotated. We do not include audit partner rotation in
15
2003 because it is not clear whether the rotation was entirely voluntary given that 2003 is
the transition year for mandatory audit-partner rotation. We only need to go back to 1999
because we already identify a total of 638 company-year observations, larger than 547
companies in our M-sample, during 1999-2002 who voluntarily rotated at least one of
their audit partners. We delete 77 observations in financial institutions and eight
observations due to less than eight companies in their industry classifications in a year,
which are needed to estimate the cross-sectional Jones (1991) model. The final VAPsample consists of 553 company-year observations.
In sum, our mandatory audit-partner rotation sample consists of 547 companies in
2004 whose audit partners (at least one of them) were mandatorily rotated (M-sample).
We construct three benchmark samples to compare with the mandatory rotation sample:
(1) companies in 2004 whose audit partners (both of them) were not required to rotate
(N04-sample); (2) the same companies in M-sample in 2003 under the old audit partners
(N03-sample); and (3) companies whose audit partners (at least one of them) were
voluntarily rotated in years before 2003 (VAP-sample).
4. Empirical Models and Findings

In this section, we examine the effect of mandatory audit-partner rotation on audit
quality and investor perceptions of audit quality. We first present the empirical model and
findings using accrual-based proxies for audit quality. We then present the empirical
model and findings using the market-based proxy for investor perceptions of audit
quality.
16
4.1. Accrual-Based Proxies for Audit Quality

4.1.1. Variable Measurement and Empirical Model
We use two measures of accruals as proxies for audit quality. Following Johnson
et al. (2002) and Myers et al. (2003), our first accrual measure is abnormal accruals
(ABNACt) estimated as the residuals from the cross-sectional modified Jones (1991)
model below (company subscript is omitted for ease of exposition):
TAC t
PPE t
SALES t ARt
1
= t
+ t
+ t
+ t
TAt 1
TAt 1
TAt 1
TAt 1
(1)
where:
TACt = total accruals in the first half of year t, calculated using the statement of
cash flow approach recommended by Hribar and Collins (2002), = income
before discontinued operations and extraordinary items (cash from
operations discontinued operations and extraordinary items from the
statement of cash flows);
SALESt = change in sales revenue between the first half of year t and the first half of
year t-1;
ARt = change in accounts receivable between the first half of year t and the first
half of year t-1;
PPEt = gross amount of property, plant and equipment at the end of the first half of
year t; and
TAt-1 = total assets at the end of year t-1 (i.e., total assets at the beginning of the
first half of year t).
We estimate equation (1) in the cross section in each year (from 1999 to 2004) for
each industry classification with at least eight observations using all companies with
required data in the TEJ database.11 The residuals from equation (1) are our measures of
abnormal accruals (ABNACt). We then keep only company-year observations in our
mandatory rotation sample (M-sample) and three benchmark samples (N04-sample, N03sample and VAP-sample).
11
Industry classification is provided by the TEJ database.
17
Our second measure of accruals is abnormal working capital accruals (AWCAt)

estimated following DeFond and Park (2001):
AWCAt =
WC t (WC t 1 / SALES t 1 ) SALES t

TAt 1
(2)
where:
WCt = noncash working capital in the first half of year t = (current assets cash
and short-term investments) (current liabilities short-term debt);
SALESt = sales revenue in the first half of year t;
TAt-1 = total assets at the end of year t-1.
We examine the effectiveness of mandatory audit-partner rotation in promoting
audit quality using the regression model below following Myers et al. (2003):
Acc = + 1 BMK + 2 Age + 3 Size + 4 IndGrw + 5 CFO + 6 Big 4 +
(3)
where:
Acc = abnormal accruals (ABNACt) or abnormal working capital accruals
(AWCAt), measured in absolute, positive and negative values;
BMK = a dummy variable equal to 1 if observations are from one of the three
benchmark samples: N04-sample, N03-sample or VAP-sample, and equal to
0 otherwise;
Age = number of years since the company went public;
Size = natural logarithm of total assets at the end of the first half of year t;
IndGrw = industry growth =
i =1
SALES i ,t /
SALES
i ,t 1
by the TEJ industry
i =1
classification, and t and t-1 refer to the first half of years t and t-1,
respectively;
CFO = cash from operations from the statement of cash flows for the first half of
year t, scaled by total assets at the end of the first half of year t-1;
Big4 = a dummy variable equal to 1 if the auditor is from a Big 4 or Big 5 audit
firm, and equal to 0 otherwise.12
We estimate equation (3) in each of the three comparison samples: M vs. N04, M
vs. N03 and M vs. VAP. Following Myers et al. (2003), we first estimate equation (3)
using the absolute value of accruals (|Acc|) as the dependent variable. We then estimate
12
The earliest year in our samples is 1999 (VAP-sample). There were still five big audit firms before 2003.
We use Big4 to represent a Big 4 audit firm or a Big 5 audit firm when appropriate.
18
equation (3) using the signed value of accruals as the dependent variable for the positive
(Acc>=0) and negative (Acc<0) sub-samples, respectively, in truncated regressions. Our
variable of primary interest is BMK. Our Hypothesis 1 predicts a positive coefficient on
BMK when using |Acc| as the dependent variable and a positive (negative) coefficient on
BMK for the positive (negative) accruals sub-sample in a truncated regression. In other
words, our first hypothesis predicts that that accruals are more extreme (i.e., absolute
values are larger or signed values are more extremely positive for the positive sub-sample
and more extremely negative for the negative sub-sample) for the benchmark sample
(i.e., BMK = 1) relative to the mandatory rotation sample (i.e., BMK = 0), i.e., accruals
are less extreme (and thus audit quality is higher) for the mandatory rotation sample as
compared to the benchmark sample.
We include several control variables for other known determinants of accruals in
equation (3) following Myers et al. (2003) and other prior studies. First, we include Age
to control for changes in accruals over a companys life cycle (Anthony and Ramesh
1992; Dechow et al. 2001). Based on Myers et al., we expect that accruals become less
extreme as a companys age increases. Second, since large companies face higher
political cost (Watts and Zimmerman 1986; 1990) and higher litigation risk (Land and
Lundholm 1993), they are likely to be less engaged in earnings management. In addition,
Dechow and Dichev (2002) suggest that large companies tend to report larger and more
stable accruals. Based on these studies, we include Size to control for the size effect and
expect that accruals for larger companies are less extreme. Third, we include IndGrw to
control for a potentially positive effect of industry growth on a companys accruals.
However, Myers et al. show a mixed relation between accruals and IndGrw. We,
19
therefore, do not predict the sign for IndGrw. Fourth, we include CFO to control for a
negative relation between accruals and cash from operations (Dechow 1994; Sloan 1996).
Based on findings in Myers et al., we expect a negative coefficient on CFO. Finally, we
include Big4 to control for prior findings that Big 4 or Big 5 audit firms tend to be more
conservative and tend to limit their clients extreme accruals. However, Myers et al. find
mixed results for Big4 and we thus do not predict the sign for Big4.
4.1.2. Empirical Findings Based on Abnormal Accruals
We report descriptive statistics for variables in equation (3) in panel A, Table 2.13
First, we compare the mandatory rotation sample (M-sample) with the non-rotation
sample in 2004 (N04-sample). The mean |ABNAC| for M-sample is 0.049 whereas that for
N04-sample is 0.058. A two-tailed t-test suggests that the difference of -0.009 is
significant at the 0.10 level. We indicate this significance by placing a # sign on the mean
|ABNAC| for N04-sample without reporting the specific t-statistic.14 Our two-tailed nonparametric Wilcoxon z-test also suggests that the median |ABNAC| for M-sample is
significantly smaller than that for N04-sample. Thus, univariate comparisons of the mean
and median |ABNAC| suggest that audit quality of the mandatory rotation sample is higher
than audit quality of the non-rotation sample, consistent with our Hypothesis 1. However,
these are only univariate tests without controlling for other determinants of abnormal
accruals. Turning to other variables, the differences in means and medians between Msample and N04-sample are all insignificant except for Big4, for which both the t-test and
13
To mitigate undue influences of extreme values, we winsorize ABNAC, Age, Size, IngGrw, and CFO at
the top and bottom 1% of their respective distributions.
14
In other words, when a mean or median value in the N04 column (or other columns) in panel A of Table 2
bears a # sign, that means the said mean or median value is significantly different from its corresponding
mean or median value for M-sample.
20
Wilcoxon z-test indicate that M-sample contains more Big 4 or Big 5 audit firms (at the
0.10 level, two-tailed).15
Second, we compare M-sample with N03-sample. We find that both the mean and
median |ABNAC| for M-sample are significantly larger (i.e., audit quality lower) than
their counterparts for N03-sample, inconsistent with our Hypothesis 1. Third, we find no
significant differences in the mean and median |ABNAC| between M-sample and VAPsample.
Next, we examine the effect of mandatory audit-partner rotation on audit quality
in a multivariate setting using equation (3). Panel B, Table 2, reports our findings using
absolute abnormal accruals (|ABNAC|) as the dependent variable. First, we find that the
coefficient on BMK is positive but not significant (0.007, t = 1.247) in the M vs.
N04column. This suggests that absolute abnormal accruals for our mandatory rotation
sample are no longer significantly lower (i.e., audit quality higher) than those for N04sample after control variables are included in equation (3). Second, the coefficient on
BMK is significantly negative (-0.007, t = -2.695) in the M vs. N03 column. This
suggests that audit quality of companies subject to mandatory audit-partner rotation in
2004 is lower than audit quality of these same companies one year ago under the old
audit partners, inconsistent with our Hypothsis 1. Third, the coefficient on BMK is
insignificant in the M vs. VAP column (-0.000, t = -0.004), suggesting that audit
quality of the mandatory rotation sample is indistinguishable from audit quality of
companies whose audit partners were voluntarily rotated in years before 2003.
15
The Wilcoxon z-test can identify a significant difference in the distribution of Big4 between M-sample
and N04-sample even when the sample medians of the two samples are equal.
21
Following Myers et al. (2003), we also estimate equation (3) for positive and
negative abnormal accruals separately.16 We report our findings from the truncated
regressions in panels C and D, Table 2. For income-increasing accruals, there is no
difference in the coefficients on BMK between the mandatory rotation sample and any
one of the three benchmark samples (see panel C). For income-decreasing accruals, on
the other hand, the coefficient on BMK is significantly negative in the M vs. N04
column (-0.014, t = -2.567), i.e., negative abnormal accruals for N04-sample is more
extremely negative as compared to those for M-sample (see panel D). This suggests that
new audit partners in M-sample appear to constrain extremely negative accruals when
compared with audit partners in the non-rotation sample (N04-sample), consistent with
Hypothesis 1 that mandatory audit-partner rotation enhances audit quality.17 However,
the coefficient on BMK becomes significantly positive in the M vs. N03 column (0.008,
t = 2.791), suggesting that old audit partners in N03-sample appear to constrain extremely
negative accruals when compared with new audit partners in M-sample, inconsistent with
our Hypothesis 1. Finally, the coefficient on BMK is insignificant (0.000, t = 0.022),
suggesting, once again, that audit quality of the mandatory rotation sample is
indistinguishable from audit quality of the voluntary rotation sample.
In sum, we have three major findings in Table 2. First, we find some weak
evidence that audit quality of the mandatory rotation sample is higher than audit quality
of the non-rotation sample (M vs. N04). Second, for companies whose audit partners are
16
Myers et al. (2003, p. 790) argue that regulators are not only concerned about the dispersion in accruals
(i.e., absolute accruals) but also about extreme income-increasing and/or income-decreasing accruals.
Income-increasing accruals can be used to inflate current earnings whereas income-decreasing accruals can
be used to create cookie jar reserves, which can be used to increase future earnings.
17
The income-decreasing earnings management has received a great deal of attention form regulators and
popular press lately (e.g., Levitt 1998).
22
mandatorily rotated in 2004, we consistently find that audit quality in the year of rotation
under the new audit partners is lower than audit quality one year ago under the old audit
partners (M vs. N03). Third, we find consistent evidence that audit quality of the
mandatory rotation sample is indistinguishable from audit quality of the voluntary
rotation sample (M vs. VAP).
The first and second findings above appear paradoxical: mandatory rotation
enhances audit quality when compared with N04-sample but impairs audit quality when
compared with N03-sample. This apparent inconsistency can be reconciled if we take
audit-partner tenure into consideration. Prior studies consistently find that audit quality
increases with audit-firm tenure (e.g., Johnson et al. 2002; Myers et al. 2003; Ghosh and
Moon 2005). The essence of these findings is that client-specific knowledge and
experience that can only be accumulated over time are vitally important for auditors to
produce a high quality audit. For N04-sample where audit partners were not required to
rotate in 2004, audit-partner tenures were all less than five years as of 2004 (average 2.99
years). In some sense, audit partners in N04 are still accumulating client-specific
knowledge and experience. The lack of such knowledge and experience for new audit
partners in M-sample, therefore, is not stark when compared to audit partners in N04sample. We conjecture that the improved auditor independence and benefit of a fresh
look resulting from mandatory rotation for new audit partners in M-sample overweigh
the relatively small disadvantage of their lack of client-specific experience relative to
N04-sample. Consequently, we observe that audit quality of the mandatory rotation
sample is weakly higher than audit quality of N04-sample. However, at least one out of
two audit partners in N03-sample had at least five years of client-specific experience as of
23
2003 before being mandatorily rotated off in 2004 (average tenure 5.64 years).18 The lack
of client-specific knowledge of new audit partners in M-sample is extreme compared
with N03-sample. We conjecture that any improved auditor independence and benefit of a
fresh look resulting from mandatory rotation for new audit partners in M-sample do not
overweigh the significant disadvantage of their lack of client-specific experience relative
to N03-sample. Consequently, we observe that audit quality of the mandatory rotation
sample is lower than audit quality of N03-sample.
Turning back to control variables in Table 2, results on Age are largely consistent
with our prediction. Specifically, absolute abnormal accruals are negatively related to
Age in all three comparisons (panel B) and so are positive accruals (panel C). However,
negative accruals become slightly more negative as Age increases, inconsistent with our
prediction (panel D). Our findings on Size are mixed and largely inconsistent with our
prediction based on prior studies. We did not make prediction for IndGrw and Big4
because findings on these two variables in Myers et al. (2003) are mixed. Finally, we
consistently find that CFO is negatively related to absolute abnormal accruals, positive
abnormal accruals and negative accruals, consistent with our prediction and Myers et al.
(2003).
4.1.3. Empirical Findings Based on Abnormal Working Capital Accruals
We also use abnormal working capital accruals (AWCA) as a second proxy for
audit quality and re-estimate equation (3). Table 3 reports our findings.19 Descriptive
18
We only trace audit-partner tenure for a maximum of 10 years. Thus, this average underestimates the true
average audit-partner tenure in our N03-sample.
19
Similar to the treatment of abnormal accruals, we winsorize AWCA, Age, Size, IngGrw, and CFO at the
top and bottom 1% of their respective distributions to mitigate the undue influence of extreme values. Also,
we lose one observation in M-sample due to missing information for calculating AWCA.
24
statistics in panel A for absolute abnormal working capital accruals (|AWCA|) are similar
to those for |ABNAC| in panel A of Table 2.
Findings from re-estimating equation (3) using abnormal working capital accruals
are reported in panels B, C and D. When the mandatory rotation sample is compared with
N04-sample (the M vs. N04 column), we find that (1) the coefficient on BMK is
significantly positive (0.026, t = 2.195) when |AWCA| is the dependent variable (panel B);
(2) the coefficient on BMK remains significantly positive (0.022, t = 1.909) in the
truncated regression for the positive abnormal working capital accruals (panel C); and (3)
the coefficient on BMK is negative but not significant (-0.030, t = -1.609) in the truncated
regression for the negative abnormal working capital accruals (panel D). These results are
stronger than those based on abnormal accruals in Table 2 and suggest that mandatory
audit-partner rotation enhances audit quality when compared with N04-sample.
When we compare the mandatory rotation sample with N03-sample or VAPsample, findings based on abnormal working capital accruals are qualitatively identical to
those based on abnormal accruals in Table 2. Specifically, we continue to observe that
audit quality of the mandatory rotation sample under the new audit partners is (i) lower
than audit quality one year ago under the old audit partners (the M vs. N03 column) and
(ii) indistinguishable from audit quality of companies whose audit partners were
voluntarily rotated in years before 2003 (the M vs. VAP column).
To summarize, our findings using abnormal working capitals are qualitatively
similar to those using abnormal accruals except that we find stronger evidence that audit
25
quality of companies subject to mandatory rotation in 2004 (M-sample) is higher than

audit quality of companies not subject to mandatory rotation in 2004 (N04-sample).
4.2. Market-Based Proxy for Investor Perceptions of Audit Quality
In this section, we use earnings response coefficients (ERC) estimated in
concurrent returns-earnings regressions as a market-based proxy for investor perceptions
of audit quality following Toeh and Wong (1993) and Ghosh and Moon (2005). We first
present the empirical model and then report our findings.
4.2.1. Empirical Model and Variable Measurement
Following Ghosh and Moon (2005), we use the following model to examine
whether investors perceive mandatory audit-partner rotation as enhancing audit quality:
CAR = + 1 E + 2 E + 3 BMK + 4 EBMK + 5 EBMK +
13
CV
j
(4)
j =6
where:
CAR = cumulative value-weighted market-adjusted abnormal returns over six
month during March-August;20
E = income from continuing operations for the first half of year t, scaled by the
market value of equity at the end of February of year t;
E = change in income from continuing operations between the first half of year t
and the first half of year t-1, scaled by the market value of equity at the end
of February of year t;
BMK = a dummy variable equal to 1 if observations are from one of the three
benchmark samples: N04-sample, N03-sample or VAP-sample, and equal to
0 otherwise;
EBMK = EBMK, the interaction between E and BMK;
CVj = one of the eight control variables discussed below.
As in Ghosh and Moon (2005), we include both earnings levels and earnings
changes in the model because prior studies show that both of them explain concurrent
20
Companies in our samples are all calendar year-end companies with semi-annual accounting periods
ending at the end of June. Since Taiwanese regulations require public companies to release semi-annual
reports within two months after the end of the semi-annual period, our return accumulation periods end in
August to ensure that semi-annual reports is released to the market and reflected in returns.
26
returns (e.g., Easton and Harris 1991; Ali and Zarowin 1992). We estimate equation (4)
over three comparison samples, M vs. N04, M vs. N03 and M vs. VAP, respectively. The
full earnings response coefficient for the mandatory rotation sample (i.e., BMK = 0) is the
sum of the coefficients on earnings levels and earnings changes (1 + 2). We are
primarily interested in the sum of the coefficients on EBMK and EBMK (4 + 5), which
is the incremental ERC for one of the three benchmark samples (i.e., BMK = 1). If
investors perceive mandatory audit-partner rotation as enhancing audit quality, then ERC
for the mandatory rotation sample will be larger than ERC for the benchmark sample.
Our Hypothesis 2, thus, predicts a negative incremental ERC for the benchmark sample,
i.e., 4 + 5 < 0. Finally, the full earnings response coefficient for a benchmark sample is
the sum of ERC for the mandatory rotation sample and the incremental ERC for the
benchmark sample (1 + 2 + 4 + 5).
We include several control variables in equation (4) following Ghosh and Moon
(2005) and prior studies. They are: (1) company age, Age, defined before; (2) auditor
type, Big4, defined before; (3) Growth potential, Growth, calculated as the sum of market
value of equity and book value of total debt divided by book value of total assets, all
measured at the end of the first half of year t; (4) earnings persistence, Persist, calculated
as the first-order autocorrelation of income from continuing operations for the past 16
quarters; (5) earnings volatility, Volaty, calculated as the standard deviation of income
from continuing operations for the past 16 quarters; (6) systematic risk, Beta, calculated
using the past 60 monthly returns; (7) size, MVE, measured as the natural logarithm of
market value of equity at the end of the first half of year t; and (8) financial leverage,
27
LEV, measured as the ratio between total debt and total assets at the end of the first half
of year t.
4.2.2. Empirical Findings Based on Earnings Response Coefficients
Due to the need for additional variables, our three comparison samples, M vs. N04,
M vs. N03 and M vs. VAP, are all reduced in size. We lose some observations due to
missing cumulative abnormal returns (CAR). The biggest source for data loss is by far the
need of 60 past monthly returns to calculate Beta. Panel A, Table 4, summarizes the
derivation process for our three comparison samples used in this part of the study. We
obtain two sets of samples. The large samples have non-missing returns, earnings levels
and earnings changes, and contain 678, 1,090 and 1,080 observations for the M vs. N04,
M vs. N03 and M vs. VAP comparison samples, respectively (see Subtotal in panel A,
Table 4). We use the large samples to estimate equation (4) without control variables. The
small samples have non-missing data for all variables in equation (4) and are used to
estimate the full model.
Panel B, Table 4, presents descriptive statistics for our three comparison
samples.21 The mean and median CAR are both positive (0.004 and 0.002) for the M vs.
N04 sample, both negative (-0.051 and -0.057) for the M vs. N03 sample, and both
negative (-0.017 and -0.025) for the M vs. VAP sample. The mean CAR is larger than
median CAR for all three samples, suggesting that returns are right skewed. The mean E
is smaller than median E for all three samples, similar to the patterns in the U.S. (see for
example, Ghosh and Moon 2005). The mean and median E are both positive, also
21
To mitigate undue influence of extreme values, we winsorize CAR, E, E, Age, Growth, Persist, Volaty,
Beta, MVE, and LEV at the top and bottom 1% of their distributions.
28
similar to the U.S. data reported in Ghosh and Moon (2005). The means of BMK for three
comparison samples are 0.192, 0.461 and 0.418, respectively, suggesting that 19.2%,
46.1% and 41.8% of these comparison samples are companies not subject to mandatory
audit-partner rotation in 2004 or earlier years. The means and medians of remaining
variables, Age, Big4, Growth, Persist, Volaty, Beta, MVE and LEV, appear similar across
three comparison samples.
We estimate equation (4) first without control variables using the large samples
(short regression) and then with control variables using the small samples (long
regression). Our findings are reported in Table 5 with the Columns 3, 5 and 7 for the
short regressions and Columns 4, 6 and 8 for the long regressions. The coefficients on
earnings levels, 1, are significantly positive for all six regressions. The coefficients on
earnings changes, 2, are positive for all six regressions but are significant only in two
regressions (Columns 4 and 6).22 The full ERC for the mandatory rotation sample (Msample) in each of six regressions is 1 + 2. F-test results (testing 1 + 2 = 0) suggest
that full ERCs for the mandatory rotation sample are highly significantly positive for all
six regressions (ERC ranging from 1.583 to 2.305; F-statistic ranging from 29.688 to
87.375). Our findings, thus, confirm prior studies that both earnings levels and earnings
changes explain concurrent returns.
22
Coefficients 1, 2 and 1 + 2 are and should be identical in short regressions in Columns 3, 5 and 7. This
is because in the short regression the dummy variable, BMK, and its interaction terms with E and E are all
included as explanatory variables. In such a specification, 1 and 2 are the coefficients for M-sample in
each of the three comparison samples: M vs. N04, M vs. N03 and M vs. VAP. On the other hand, 4 and 5
are the incremental coefficients for the benchmark sample. Since M-sample remains the same in each of the
three comparison samples, 1, 2 and 1 + 2 should be identical in short regressions in Columns 3, 5 and 7.
This, however, is not true for the long regressions because we only include control variables but not their
interaction terms with E and E in the long regression specification.
29
Our primary interest is the incremental ERC (4 + 5) for the benchmark sample.
In all six regressions, the incremental ERCs for the benchmark samples are significantly
negative (ERC ranging from -0.746 to -1.880; F-statistic ranging from 3.788 to 43.046).
That is, the full ERC for each benchmark sample, N04-sample, N03-sample or VAPsample, is smaller than the full ERC for the mandatory rotation sample (M-sample) in
each of the three comparison samples. This suggests that investors perceive mandatory
audit-partner rotation as enhancing audit quality, consistent with our Hypothesis 2.
Lastly, the full ERC for each benchmark sample is significantly positive except for
Column 6 where the full ERC is insignificant (0.447, F-statistic = 1.488).
Next, we briefly discuss control variables below. The coefficients on Age and
Big4 are insignificant for all three long regressions but they are both significantly positive
in Ghosh and Moon (2005). We find that investors positively price growth potential as
the coefficients on Growth are significantly positive in all three regressions, consistent
with Ghosh and Moon and prior studies. The coefficient on Persist is insignificant for all
three regressions but it is significantly positive in Ghosh and Moon. Our coefficient on
Volaty (Beta) is generally insignificant (significantly negative) whereas the coefficient on
Volaty (Beta) in Ghosh and Moon is significantly negative (insignificant). The coefficient
on MVE is significantly positive in two regressions (Columns 4 and 6) whereas it is
insignificant in Ghosh and Moon. Finally, the coefficient on LEV is insignificant in two
out of three regressions, consistent with Ghosh and Moon.
To summarize, our analyses using earnings response coefficients as a proxy for
investor perceptions of audit quality suggest that investors perceive mandatory auditpartner rotation as enhancing audit quality. We conjecture that mandatory audit-partner
30
rotation improves auditor independence in appearance. Consequently, investors perceive

mandatory audit-partner rotation as quality enhancing.
4.3. Additional Analyses
We conduct several additional analyses to test the robustness of our findings.
First, we calculate abnormal accruals using three alternative models: (1) the Jones (1991)
model, which is similar to equation (1) except that change in accounts receivable (ARt)
is not subtracted from change in sales revenue (SALESt); (2) performance-matched
modified Jones model; and (3) performance-matched Jones model. We calculate
performance-matched abnormal accruals following Kothari, Leone and Wasley (2005) in
a two-stage process. In the first stage, we calculate abnormal accruals using the modified
Jones model and Jones model, respectively, in the cross-section in each year (from 1999
to 2004) for each industry classification with at least eight observations using all
companies with required data in the TEJ database as we did before. In the second stage,
we do performance matching based on current period return on assets. Specifically, for
each company j (j = 1, 2, ..., N and N >= 8) in an industry-year combination in year t, we
find another company i, i j, among the remaining companies (N 1) in the same
industry-year combination whose return on assets in year t (ROAit) is closest to return on
assets of company j (ROAjt). Performance-matched modified Jones (Jones) model
abnormal accruals for firm j are the differences in modified Jones (Jones) model
abnormal accruals between firm j and firm i.
With abnormal accruals estimated using the above three alternative models, we
re-estimate equation (3). To save space, we only report the coefficient on BMK in Table
31
6.23 To facilitate comparison, we repeat our main findings in Table 2 at the top of each
panel in Table 6. Overall, results based on these three alternative models are qualitatively
similar to our main results except for the following cases. First, the coefficients on BMK
in the M vs. N03 column in panel B are significantly negative for both performancematched modified Jones model and performance-matched Jones model, suggesting that
abnormal accruals of the mandatory rotation sample are more extremely positive relative
to the N03-sample for the positive abnormal accrual sub-sample. Thus, with performancematched abnormal accruals, we find even stronger evidence that audit quality of
companies mandatorily rotated in 2004 under new audit partners is lower than audit
quality of these same companies one year ago under old audit partners. Second, the
coefficients on BMK in the M vs. N04 column in panel C are insignificant for both
performance-matched abnormal accruals, suggesting that, with performance-matched
abnormal accruals, we no longer find that audit quality of the mandatory rotation sample
is higher than audit quality of companies whose audit partners were not required to
rotated in 2004. Third, the coefficient on BMK in the M vs. VAP column in panel C is
significantly positive (0.009, t = 1.728) for the performance-matched modified Jones
model, which provides some weak evidence that audit quality of the mandatory rotation
sample is lower than audit quality of companies whose audit partners are voluntarily
rotated in years before 2003.
Next, we use current accruals calculated below as another proxy for audit quality
following Myers et al. (2003):
23
Again, we winsorize Acc, Age, Size, IngGrw, and CFO at the top and bottom 1% of their respective
distributions to mitigate the undue influence of extreme values.
32
CAC =
(CA Cash ) (CL STD )

TA 1
(5)
where:
CA = change in current assets between the first half of year and the second half
of year -1;24
Cash = change in cash and cash equivalent between the first half of year and the
second half of year -1;
CL = change in current liabilities between the first half of year and the second
half of year -1;
STD = change in short-term debt between the first half of year and the second
half of year -1;
TA-1 = total assets at the end of year -1.
We re-estimate equation (3) using current accruals (CAC) as the dependent
variable and report the coefficient on BMK in Table 6. In the M vs. N04 column, the
coefficient on BMK is significantly positive in panel A and significantly negative in panel
C, consistent with prior results in Tables 2 and 3. In the M vs. N03 column, the
coefficient on BMK is significantly negative in panel A and panel B as expected. In the
M vs. VAP column, the coefficient on BMK is insignificant in all three panels, consist
with prior findings in Tables 2 and 3.
Finally, Ghosh and Moon (2005) argue that earnings response coefficients
estimated from equation (4) might be biased downwards due to prices leading earnings
(see also, Kothari 1992; Kothari and Sloan 1992). Following Ghosh and Moon, we
measure cumulative abnormal returns (CAR) over an eight-month period (JanuaryAugust) ending two months after the end of the semi-annual period.25 The results using
the eight-month cumulative abnormal returns are qualitatively unchanged as compared to
24
The value of a balance sheet item at the end of the second half of year -1 is the same as the value of that
item at the end of year -1.
25
The deflator for E and E is the market value of equity at the end of previous year for this analysis.
33
Table 5. In untabulated results, we continue to observe that ERC for the mandatory
rotation sample is higher than ERC for each of the three benchmark samples.
In sum, results from the sensitivity tests are generally consistent with results in
Tables 2, 3 and 5. The only exceptions are (1) we no longer observe that audit quality of
companies subject to mandatory rotation in 2004 (M-sample) is higher than audit quality
of companies not subject to mandatory rotation in 2004 (N04-sample) using two
performance-matched accrual measures and (2) the coefficient on BMK in the M vs.
VAP column becomes significantly positive at the 0.10 level in panel C for the
performance-matched modified Jones model.
5. Conclusion
Audit-partner rotation has existed in the U.S. for some time and is recently
strengthened in the SOX Act. An implicit assumption in the SOX Act is that mandatory
audit-partner rotation improves auditor independence and enhances audit quality.
However, this assumption is not tested in the literature due to the lack of audit-partner
information in the U.S. audit reports. We examine the effectiveness of mandatory auditpartner rotation in promoting audit quality using Taiwanese data. Audit-partner rotation
has been entirely voluntary in Taiwan until 2003 when two main Taiwanese stock
exchanges introduced regulations that, in effect, require a five-year mandatory auditpartner rotation. In addition, Taiwanese audit reports contain both audit-firm names and
two signing audit-partner names, allowing researchers to identify years in which audit
partners are rotated either voluntarily or mandatorily. These important features of
34
Taiwanese data provide a unique opportunity for us to examine the effectiveness of

mandatory audit-partner rotation in promoting audit quality.
Following Myers et al. (2003) and Johnson et al. (2002), we first use two accrualbased proxies for audit quality: abnormal accruals and abnormal working capital accruals.
We find three main results. First, audit quality of companies subject to mandatory auditpartner rotation in 2004 is higher (i.e., accrual measures are less extreme) than audit
quality of companies not subject to mandatory rotation in 2004. Second, for companies
whose audit partners were mandatorily rotated in 2004, audit quality in 2004 under the
new audit partners is lower than audit quality one year ago under the old audit partners.
Third, audit quality of companies subject to mandatory audit-partner rotation in 2004 is
indistinguishable from audit quality of companies whose audit partners were voluntarily
rotated in years before 2003. The effect of mandatory audit-partner rotation on audit
quality, therefore, is mixed. Our findings based on Taiwanese data imply that the
effectiveness of the mandatory audit-partner rotation clause in the SOX Act in promoting
audit quality, measured in terms of auditors constraining managements extreme incomeincreasing or extreme income-decreasing accruals, may be limited.
We also examine the effect of mandatory audit-partner rotation on investor
perceptions of audit quality, as measured by the earnings response coefficient, following
Teoh and Wong (1993) and Ghosh and Moon (2005). We find that ERC for our
mandatory rotation sample is significantly higher than that for each of our three
benchmark samples. We, thus, consistently find that investors perceive mandatory audit
partner rotation as enhancing audit quality, which, we conjecture, is due to improved
auditor independence in appearance. Since perceptions are very important for audit
35
services due to difficulty in directly observing audit quality, our findings imply that the
mandatory audit-partner rotation clause in the SOX Act is of value in improving auditor
independence in appearance.
Several caveats must be considered when interpreting the findings of this study.
First, our findings are based on the first set of semi-annual reports currently available
after the mandatory audit-partner rotation became fully effectively in 2004 in Taiwan.
Examining the effect of mandatory audit-partner rotation on audit quality/perceived audit
quality using the first set of data after the implementation of the rule is of interest in its
own right. In addition, it affords more powerful tests due to a large percentage of
companies whose audit-partners need to rotate in the first year (that percentage will
become smaller in later years). However, our short-term examination of mandatory auditpartner rotation also has disadvantages. Specifically, it may take some time for
mandatory audit-partner rotation to affect audit quality due to the time needed for new
audit-partners to accumulate client-specific knowledge and experience, although it is
ultimately an empirical question as to the time frame. Findings in this study, therefore,
are only the first piece of evidence on the effectiveness of mandatory audit-partner
rotation in promoting audit quality. Future research can use Taiwanese data over a longer
period to examine the effect of mandatory audit-partner rotation on audit quality and the
relation between audit-partner tenure and audit quality under the mandatory audit-partner
rotation regime. Future research on investor perceptions of audit quality over a longer
horizon under the mandatory audit-partner rotation regime is of particular interest
because the perceived value of mandatory audit-partner rotation can change when
mandatory rotation becomes normality.
36
Second, although our findings have implications for the U.S. audit market they
may not be generalizable to a post SOX Act U.S. audit market due to institutional
differences between Taiwan and the U.S. We note, however, important empirical
regularities in the U.S. audit market (e.g., Myers et al. 2003) can be replicated using
Taiwanese data (e.g., Chen et al. 2004). Thus, there are significant similarities between
the two markets, making our findings relevant for the U.S. audit market. Finally, we use
only one proxy for investor perceptions of audit quality. Future research can use
alternative proxies, such as cost of capital (debt and equity) and analysts reliance on
reported earnings in forecasting future earnings, to further examine the effect of
mandatory audit-partner rotation on perceptions of audit quality.
37
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40
TABLE 1
Sample selection
Panel A: M and N04 sample selection
Companies listed on TSEC or GTSM in 2002 from the TEJ database
1,022
Less:
Companies with missing audit-partner information

Companies with non-calendar year end
Preliminary sample
(21)
(3)
998
Sample label
Preliminary sample
M
832
N04
166
Less:
(30)
(78)
(7)
(0)
(109)
(0)
(1)
(0)
(15)
(28)
(0)
(18)
(6)
(0)
(0)
(0)
(0)
(0)
(23)
(2)
547
134
Companies delisted in 2003 or 2004

Companies switching audit firms in 2003 or 2004
Companies rotating one audit partner in 2003 but the audit partner came
back in 2004
Companies rotating both audit partners in 2003 but one of them came back
in 2004
Companies rotating both audit partners in 2003 but both came back in 2004
Companies should rotate one audit partner but rotated none
Companies should rotate both audit partners but rotated only one
Companies should rotate both audit partners but rotated none
Companies in financial institutions
Companies with less than eight observations in a industry-year combination
Final sample
Panel B: VAP sample selection
2002
2001
2000
1999
Number of Companies
157
220
143
118
Cumulative Company-Year Obs.

157
377
520
638
Less:
Observations in financial institutions

Observations with fewer than eight companies in a
industry-year combination
Final sample
41
(77)
(8)
553
TABLE 2
Abnormal accruals and mandatory audit-partner rotation
Panel A: Descriptive statistics
Sample label
|ABNAC|
Age
Size
IndGrw
CFO
Big4
Mean
Median
Std. Dev.
Mean
Median
Std. Dev.
Mean
Median
Std. Dev.
Mean
Median
Std. Dev.
Mean
Median
Std. Dev.
Mean
Median
Std. Dev.
Sample size
N04
0.058#
0.037#
0.073
9.440
6.000
9.023
22.225
22.011
1.261
1.039
1.024
0.089
-0.003
0.001
0.089
0.754#
1.000#
0.432
134
M
0.049
0.031
0.055
8.817
7.000
7.232
22.234
22.049
1.226
1.040
1.024
0.075
0.006
0.012
0.072
0.819
1.000
0.385
547
N03
0.040###
0.027##
0.043
7.817##
6.000###
7.232
22.118
21.935#
1.205
1.005###
1.016###
0.059
0.018###
0.017##
0.059
0.819
1.000
0.385
547
VAP
0.046
0.032
0.047
7.691##
5.000###
8.621
22.229
22.114
1.176
0.994###
0.999###
0.108
0.018###
0.020##
0.061
0.807
1.000
0.395
553
Panel B: Absolute abnormal accruals (|ABNAC|) results

Variable
Intercept
M vs. N04
M vs. N03
M vs. VAP
0.054
0.113***
0.033
(1.162)
(3.169)
(1.029)
0.007
-0.007***
-0.000
(1.247)
(-2.695)
(-0.004)
-0.001***
-0.001***
-0.001***
(-5.372)
(-7.746)
(-8.380)
*
0.003
-0.000
0.001
(1.871)
(-0.016)
(1.011)
-0.061**
-0.052**
-0.004
(-2.258)
(-2.290)
(-0.234)
-0.442***
-0.354***
-0.349***
(-8.444)
(-8.668)
(-8.386)
0.005
0.003
0.006**
(1.207)
(0.880)
(1.978)
0.351
0.264
0.237
681
1,094
1,100
(This table is continued on the next page)
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
42
TABLE 2 (Continued)
Panel C: Positive abnormal accruals (ABNAC >= 0) results
Variable
Intercept
M vs. N04
-0.266***
(-4.277)
-0.007
(-1.098)
-0.002***
(-5.786)
0.013***
(6.209)
0.025
(0.626)
-0.707***
(-15.059)
0.005
(0.871)
0.654
347
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
M vs. N03
-0.143***
(-3.476)
-0.002
(-0.632)
-0.001***
(-8.311)
0.008***
(5.050)
0.025
(0.927)
-0.650***
(-18.308)
0.002
(0.538)
0.594
556
M vs. VAP
-0.122***
(-3.265)
-0.000
(-0.094)
-0.001***
(-7.930)
0.007***
(4.292)
0.026
(1.344)
-0.650***
(-19.139)
0.006
(1.318)
0.596
575
M vs. N03
-0.320***
(-8.083)
0.008***
(2.791)
-0.000*
(-1.781)
0.009***
(7.985)
0.099***
(4.137)
-0.262***
(-7.578)
-0.001
(-0.202)
0.220
538
M vs. VAP
-0.202***
(-5.298)
0.000
(0.022)
-0.000
(-1.381)
0.006***
(4.343)
0.045**
(2.457)
-0.339***
(-8.746)
-0.002
(-0.688)
0.203
525
Panel D: Negative abnormal accruals (ABNAC < 0) results

Variable
Intercept
M vs. N04
-0.314***
(-6.242)
-0.014**
(-2.567)
-0.000*
(-1.944)
0.010***
(6.107)
0.075***
(2.759)
-0.241***
(-5.139)
-0.001
(-0.256)
0.176
334
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
Notes:
# ## ###
, , Difference in mean (median) between the mandatory rotation sample and the benchmark sample significant at
the 0.10, 0.05, and 0.01 level using a two-tailed t-test (Wilcoxon z-test) in panel A.
* ** ***
, ,
Significant at the 0.10, 0.05, and 0.01 level, respectively, based on a two-tailed t-test using Whites (1980)
heteroscedasticity-corrected standard error in panels B, C and D.
ABNAC
BMK
= abnormal accruals, measured in absolute, positive and negative values;

= a dummy variable equal to 1 if observations are from one of the three benchmark samples: N04-sample, N03sample or VAP-sample, and equal to 0 otherwise;
43
Age
Size
= number of years since the company went public;

= natural logarithm of total assets at the end of the first half of year t;
N
IndGrw
CFO
Big4
= industry growth = i =1 SALES i ,t / i =1 SALES i ,t 1 by the TEJ industry classification, and t and t-1 refer to the first
half of years t and t-1, respectively;
= cash from operations from the statement of cash flows for the first half of year t, scaled by total assets at the
end of the first half of year t-1;
= a dummy variable equal to 1 if the auditor is from a Big 4 or Big 5 audit firm, and equal to 0 otherwise.
44
TABLE 3
Abnormal working capital accruals and mandatory audit-partner rotation
Panel A: Descriptive statistics
Sample label
|AWAC|
Mean
Median
Std. Dev.
Sample size
N04
0.101###
0.056##
0.133
134
M
0.073
0.049
0.077
546
N03
0.066#
0.046
0.063
546
VAP
0.081
0.050
0.103
553
Panel B: Absolute abnormal working capital accruals (|AWAC|) results

Variable
Intercept
M vs. N04
M vs. N03
M vs. VAP
0.243***
0.272***
0.163***
(2.997)
(4.673)
(2.813)
0.026**
-0.011**
0.002
(2.195)
(-2.379)
(0.311)
-0.000
-0.000
-0.001***
(-0.324)
(-0.908)
(-2.662)
*
0.000
-0.004
0.003
(0.165)
(-1.903)
(1.359)
-0.159**
-0.106**
-0.134***
(-2.572)
(-2.528)
(-3.092)
***
**
-0.144
-0.091
-0.116**
(-2.589)
(-2.286)
(-2.027)
-0.014
-0.005
-0.013
(-1.489)
(-0.891)
(-1.624)
0.046
0.026
0.034
680
1,092
1,099
(This table is continued on the next page)
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
45
TABLE 3 (Continued)
Panel C: Positive abnormal working capital accruals (AWAC >= 0) results
Variable
Intercept
M vs. N04
0.076
(0.703)
0.022*
(1.909)
-0.000
(-0.166)
0.000
(0.125)
-0.007
(-0.117)
-0.288***
(-4.199)
-0.009
(-0.811)
0.094
313
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
M vs. N03
0.185**
(2.322)
-0.004
(-0.648)
-0.000
(-0.332)
-0.002
(-0.782)
-0.052
(-1.007)
-0.231***
(-4.652)
-0.011
(-1.265)
0.050
515
M vs. VAP
0.165**
(2.332)
-0.004
(-0.685)
-0.001
(-1.087)
-0.002
(-0.657)
-0.045
(-1.240)
-0.230***
(-4.377)
-0.001
(-0.111)
0.052
512
M vs. N03
-0.396***
(-4.714)
0.016***
(2.682)
0.000
(0.528)
0.005**
(2.000)
0.197***
(3.025)
-0.071
(-1.237)
0.003
(0.347)
0.038
577
M vs. VAP
-0.178**
(-1.982)
-0.008
(-1.052)
0.002**
(2.551)
-0.007*
(-1.922)
0.223***
(3.026)
0.018
(0.178)
0.023*
(1.796)
0.055
587
Panel D: Negative abnormal working capital accruals (AWAC < 0) results

Variable
Intercept
M vs. N04
-0.487***
(-3.663)
-0.030
(-1.609)
-0.000
(-0.524)
0.001
(0.245)
0.367***
(3.189)
-0.086
(-0.992)
0.024
(1.479)
0.071
367
Pred. sign
?
BMK
Age
Size
IndGrw
CFO
Big4
Adjusted R2
No. of observations
Notes:
, , Difference in mean (median) between the mandatory rotation sample and the benchmark sample significant at
the 0.10, 0.05, and 0.01 level using a two-tailed t-test (Wilcoxon z-test) in panel A.
* ** ***
, ,
heteroscedasticity-corrected standard error in panels B, C and D.
# ## ###
AWCA
= abnormal working capital accruals, measured in absolute, positive and negative values.
See Table 2 for definitions of other variables.
46
TABLE 4
Sample selection and descriptive statistics
Panel A: Sample selection for market-based tests of audit quality
M vs. N04
681
(3)
678
(221)
(9)
448
Sample label
Original sample size
Less:
Missing CAR
Subtotal: Number of observations with returns data
Less:
Missing Beta
Missing Persist and Volaty
Final sample
M vs. N03
1,094
(4)
1,090
(404)
(15)
671
M vs. VAP
1,100
(20)
1,080
(443)
(15)
622
Panel B: Descriptive statistics

Sample
CAR
E
E
BMK
Age
Big4
Growth
Persist
Volaty
Beta
MVE
LEV
M vs. N04 (N = 448)

M vs. N03 (N = 670)
M vs. VAP (N = 622)
Mean
Median Std. Dev. Mean
Median Std. Dev. Mean
Median Std. Dev.
0.004
0.002
0.202
-0.051
-0.057
0.245
-0.017
-0.025
0.283
-0.004
0.027
0.209
0.006
0.025
0.077
-0.002
0.021
0.087
0.019
0.013
0.092
0.014
0.009
0.065
0.008
0.007
0.081
0.192
0.000
0.394
0.461
0.000
0.499
0.418
0.000
0.494
11.500
9.000
7.921
11.252
9.000
7.508
12.035
9.000
8.423
0.772
1.000
0.420
0.790
1.000
0.408
0.783
1.000
0.413
1.126
1.018
0.403
1.098
0.985
0.418
1.144
0.993
0.529
0.216
0.208
0.346
0.215
0.190
0.331
0.188
0.174
0.324
0.436
0.343
0.317
0.417
0.321
0.311
0.474
0.341
0.468
1.006
1.003
0.439
0.976
0.960
0.440
0.934
0.891
0.413
21.861
21.770
1.480
21.884
21.766
1.430
21.961
21.833
1.459
0.454
0.446
0.178
0.424
0.418
0.162
0.442
0.434
0.167
CAR
E
= cumulative value-weighted market-adjusted abnormal returns over six month during March-August;
= income from continuing operations for the first half of year t, scaled by the market value of equity at the
end of February of year t;
E
= change in income from continuing operations between the first half of year t and the first half of year t-1,
scaled by the market value of equity at the end of February of year t;
BMK
= a dummy variable equal to 1 if observations are from one of the three benchmark samples: N04-sample,
N03-sample or VAP-sample, and equal to 0 otherwise;
EBMK
= EBMK, the interaction between E and BMK;
Age
= number of years since the company went public;
Big4
= a dummy variable equal to 1 if the auditor is from a Big 4 or Big 5 audit firm, and equal to 0 otherwise;
Growth = the sum of market value of equity and book value of total debt divided by book value of total assets, all
measured at the end of the first half of year t;
Persist = the first-order autocorrelation of income from continuing operations for the past 16 quarters;
Volaty
= the standard deviation of income from continuing operations for the past 16 quarters;
MVE
= the natural logarithm of market value of equity at the end of the first half of year t;
LEV
= the ratio between total debt and total assets at the end of the first half of year t.
47
TABLE 5
Investor perceptions of mandatory audit-partner rotation
Variable
(1)
Intercept
Coefficients
(2)
BMK
EBMK
EBMK
M vs. N04
(3)
-0.028***
(-3.119)
1.949***
(7.617)
0.356
(1.508)
-0.027
(-1.289)
-1.769***
(-6.723)
-0.111
(-0.394)
M vs. N03
M vs. VAP
(7)
(8)
(4)
(5)
(6)
-0.372***
(-2.843)
1.153***
(4.344)
0.486**
(2.064)
-0.015
(-0.664)
-1.077***
(-4.101)
-0.286
(-1.060)
-0.028***
(-3.119)
1.949***
(7.617)
0.356
(1.508)
-0.075***
(-4.911)
-0.839**
(-2.290)
0.042
(0.125)
-0.887***
(-5.217)
1.116***
(3.908)
0.467*
(1.844)
-0.121***
(-7.204)
-0.865**
(-2.381)
-0.272
(-0.786)
-0.028***
(-3.119)
1.949***
(7.617)
0.356
(1.508)
-0.012
(-0.635)
-0.933**
(-2.345)
0.188
(0.529)
0.111
(0.683)
1.654***
(6.108)
0.234
(0.963)
-0.052**
(-2.015)
-0.935***
(-2.639)
0.057
(0.155)
1.639***
[32.045]
-1.364***
[19.611]
0.275**
[5.023]
2.305***
[87.375]
-0.797*
[3.788]
1.508***
[21.277]
1.583***
[29.688]
-1.137**
[6.421]
0.447
[1.488]
2.305***
[87.370]
-0.746**
[3.959]
1.559***
[30.508]
1.888***
[44.204]
-0.879**
[4.504]
1.009***
[10.164]
0.209
1,090
-0.001
(-1.114)
-0.015
(-0.711)
0.057*
(1.938)
0.033
(1.370)
-0.005
(-0.120)
-0.054***
(-2.596)
0.042***
(4.503)
-0.063
(-1.070)
0.305
671
0.157
1,080
0.002
(1.512)
0.020
(0.756)
0.128***
(3.464)
0.010
(0.341)
0.001
(0.026)
-0.063**
(-2.358)
-0.011
(-1.235)
0.008
(0.117)
0.201
622
F-Test
2.305***
1+2
[F-statistic] [87.081]
-1.880***
4+5
[F-statistic] [43.046]
0.425***
1+2+4+5
[8.588]
[F-statistic]
Control variables
Age
6
Big4
Growth
Persist
Volaty
10
Beta
11
MVE
12
LEV
13
Adjusted R2
No. of observations
0.288
678
0.001
(1.092)
0.006
(0.336)
0.081***
(3.310)
0.013
(0.524)
-0.067*
(-1.939)
-0.101***
(-5.234)
0.019***
(2.746)
-0.091*
(-1.821)
0.409
448
Notes:
* ** ***
, ,
heteroscedasticity-corrected standard error or a two-tailed F-statistic. All variables are defined in Table 4.
48
TABLE 6
Alternative measures of accruals and mandatory audit-partner rotation
Panel A: Absolute abnormal accruals (|ABNAC|) or current accruals (|CAC|) results
Accrual measure
Modified Jones model
Pred. sign
+
Jones model
Performance-matched modified Jones model
Performance-matched Jones model
Current accruals
M vs. N04
0.007
(1.247)
0.008
(1.578)
0.004
(0.561)
0.005
(0.792)
0.010*
(1.73)
M vs. N03
-0.007***
(-2.695)
-0.007***
(-2.652)
-0.011***
(-3.007)
-0.011***
(-2.988)
-0.009***
(-2.81)
M vs. VAP
-0.000
(-0.004)
-0.001
(-0.365)
-0.001
(-0.203)
-0.002
(-0.419)
0.002
(0.50)
Panel B: Positive abnormal accruals (ABNAC >= 0) or current accruals (CAC >= 0) results
Accrual measure
Pred. sign
+
Jones model
Current accruals
M vs. N04
-0.007
(-1.098)
-0.004
(-0.664)
-0.005
(-0.664)
-0.007
(-0.890)
0.007
(0.84)
M vs. N03
-0.002
(-0.632)
0.001
(0.169)
-0.010**
(-2.435)
-0.011**
(-2.401)
-0.013***
(-2.56)
M vs. VAP
-0.000
(-0.094)
-0.002
(-0.583)
0.002
(0.408)
-0.002
(-0.370)
0.008
(1.19)
Panel C: Negative abnormal accruals (ABNAC < 0) or current accruals (CAC< 0) results
Accrual measure
Pred. sign
Jones model
Current accruals
M vs. N04
-0.014**
(-2.567)
-0.017***
(-2.771)
-0.005
(-0.610)
-0.011
(-1.485)
-0.014*
(-1.91)
M vs. N03
0.008***
(2.791)
0.008***
(2.817)
0.012**
(2.536)
0.011**
(2.370)
0.004
(1.07)
M vs. VAP
0.000
(0.022)
-0.002
(-0.541)
0.009*
(1.728)
0.007
(1.303)
0.005
(1.59)
Notes:
* ** ***
, ,
heteroscedasticity-corrected standard error in panels A, B and C.
49

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Mandatory Audit-Partner Rotation, Audit Quality

National Chengchi University

Oregon State University

24 PUBLICATIONS 176 CITATIONS

8 PUBLICATIONS 104 CITATIONS

National Chengchi University

17 PUBLICATIONS 990 CITATIONS

Available from: Wuchun Chi

Mandatory Audit-Partner Rotation, Audit Quality and Market Perception:

*Corresponding author. Department of Accountancy, University of Illinois at Urbana-Champaign, 1206

Mandatory Audit-Partner Rotation, Audit Quality and Market Perception:

Mandatory Audit-Partner Rotation, Audit Quality and Market Perception:

2. Taiwanese Regulation and Hypothesis Development

turn, depends on auditor competence and independence. Auditor independence, therefore,

3. Sample Selection and Data

4. Empirical Models and Findings

4.1. Accrual-Based Proxies for Audit Quality

Industry classification is provided by the TEJ database.

Our second measure of accruals is abnormal working capital accruals (AWCAt)

WC t (WC t 1 / SALES t 1 ) SALES t

by the TEJ industry

quality of companies subject to mandatory rotation in 2004 (M-sample) is higher than

rotation improves auditor independence in appearance. Consequently, investors perceive

(CA Cash ) (CL STD )

Taiwanese data provide a unique opportunity for us to examine the effectiveness of

Companies with missing audit-partner information

Companies delisted in 2003 or 2004

Cumulative Company-Year Obs.

Observations in financial institutions

Panel B: Absolute abnormal accruals (|ABNAC|) results

Panel D: Negative abnormal accruals (ABNAC < 0) results

= abnormal accruals, measured in absolute, positive and negative values;

= number of years since the company went public;

Panel B: Absolute abnormal working capital accruals (|AWAC|) results

Panel D: Negative abnormal working capital accruals (AWAC < 0) results

Panel B: Descriptive statistics

M vs. N04 (N = 448)

Performance-matched modified Jones model

Performance-matched Jones model

Performance-matched modified Jones model

Performance-matched Jones model

Performance-matched modified Jones model

Performance-matched Jones model

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