(The) effect of mandatory auditor rotation on real activities manipulation

Abstract

During 2006 through 2008, FSC has temporarily implemented mandatory auditor rotation. Under this regulation, maximum auditor retention period is limited for 6 years. Extant literatures show conflicting evidences regarding the impact of auditor rotation based on accrual-based manipulation. However, accrual manipulation is one way of doing earnings management and firms adjust earnings by real activities manipulation as well. This study investigates the effect of mandatory auditor rotation on real activities manipulation in firms that rotated auditors mandatorily. The empirical results show firms subjected to mandatory auditor rotation exhibit significantly lower real activities manipulation compared to other firms. In addition, these mandatorily rotated firms show lower real activities manipulation in changed year compared to prior year. The results are robust when additional variables that affect real activities manipulation are controlled. This study suggests additional insights and judgement basis on the impact of mandatory auditor rotation by examining changes in real activities manipulation.