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How Investors Perceive Mandatory Audit Firm Rotation in Korea

Sook Min Kim (), Seon Mi Kim (), Dong Heun Lee () and Seung Weon Yoo ()
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Sook Min Kim: Finance and Operations Management Department, Solbridge International School of Business, 128 Uam-ro, Dong-gu, Deajeon 34613, Korea
Seon Mi Kim: College of Business Administration, Chonnam National University, 77 Yongbong-ro, Buk-gu, Gwangju 61186, Korea
Dong Heun Lee: College of Global Business, Korea University, 2511 Sejong-ro, Sejong 30019, Korea
Seung Weon Yoo: Korea University Business School, 145 Anam-ro, Seongbuk-gu, Seoul 02841, Korea

Sustainability, 2019, vol. 11, issue 4, 1-17

Abstract: Credible audit quality is a precondition for a firm’s sustainability. External auditors offer assurance with regard to the uncertain factors that can jeopardize a firm’s sustainability and provide audit opinions that help investors assess risk. After the global crisis and accounting scandals, mandatory audit firm rotation has been implemented globally. However, few studies have investigated either the cost or the benefit of mandatory audit firm rotation. Prior studies provide only indirect evidence on the effects of audit firm tenure on audit quality/perceived audit quality. By discussing prior arguments, we examine how investors perceive the implementation of mandatory audit firm rotation in Korea. Using a unique and direct setting to examine our research question, we analyze the relationship between firms with mandatorily switched audit firms and the cost of equity capital from 2006 to 2008. We find that the mandatory change in the auditors has a negative association with the cost of equity capital. The results are robust to using the arithmetic mean of the cost of equity capital, lagged control variables, and the manufacturing industry effect. The results indicate that investors perceive that mandatory audit firm rotation provides an environment for qualified audits by enhancing auditor independence and skepticism, and thus decreases the cost of equity capital. This study helps to improve our understanding of the impact of mandatory audit firm rotation the information risk evaluations and provides political implications for policy makers by showing the benefit of mandatory audit firm rotation.

Keywords: mandatory auditor rotation; cost of equity capital; audit quality perception; information risk (search for similar items in EconPapers)
JEL-codes: Q Q0 Q2 Q3 Q5 Q56 O13 (search for similar items in EconPapers)
Date: 2019
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