Keywords

Mandatory Audit Firm Rotation, Audit Quality, Industry Specialization.

Introduction

Auditor’s independence and audit quality are crucial for the effectiveness and success of the auditing examination. They are considered to be the cornerstones of the auditing examination (Coyle, 2010). External users need objective, relevant, and reliable information about clients’ performance, resources, and liabilities. The European Commission (2010) argued that external users seek independent assurance provided by audit firms in order to reduce the risk that financial information are misstated.

While auditor’s independence is clearly defined in the Principles of Professional Conduct, many corporate scandals and collapses were deemed to have occurred because of lacking auditor’s independence (Said & Khasharmeh, 2014; Sayyar et al., 2014; M.Phil & Adebiyi, 2013). Moreover, the Auditing Practice Board (APB) sought to develop its standards to increase value to the audit function. The board drew attention to the risks that affect auditor’s independence, particularly as a result of auditors becoming too conversant with their clients (Porter et al., 2014).

One of the reasons which could impair auditor’s independence is audit firm tenure if the audit tenure lasts for many years (M.Phil & Adebiyi, 2013). The concern about audit firm tenure arises as a result of the notion that, if the audit firm and the client have been in close association for a long time this may weaken auditors’ ability to provide audit services with full objectivity, non-biases and threaten their ability to perform audits independently. Moreover, auditors might lose their professional skepticism during the audit engagement, which results in low audit quality (Hamilton et al., 2005).

In order to guard investors from the likelihood of deceitful accounting actions by corporations (Kaplan & Mauldin, 2008) and re-establish the public confidence in the credibility of audited financial statements (Tagesson et al., 2006), the Congress in the USA enacted the Sarbanes-Oxley Act in 2002. This Act includes more provisions and mandates certain studies. These provisions apply to publicly held companies and their audit firms. One of which (contained in Section 203) simply mandated the rotation of auditors and determined by five years in which an auditor is permitted to provide audit services to the same client. Another related requirement (contained in Section 207) required the General Accounting Office (GAO) to conduct a review the prospect effects of requiring the mandatory rotation of restrictive public accounting companies (SOX, 2002).

Researchers’ debates essentially concentrated on whether auditor’s independence is being affected once the tenure is long and consequently this impaired independence affects audit quality (Imhoff, 2003). Independence of auditors is doubted when they have audited the same client for long periods. This view has led to the suggestion that audit firm rotation become mandatory to mitigate the forums of auditor’s independence generated by familiarity and self-interest in the context of long audit firm tenure (Harris & Whisenant, 2012; M.Phil & Adebiyi, 2013).

Moreover, all the debates surrounding this issue are motivated by the need to ensure that mandatory audit firm rotation (MAFR) positively impact audit quality (Dandago & Zamro, 2013). In Egypt, clients retain the audit firm for long periods with more confidence within the quality of Big4 audit firms (Wahdan et al., 2005). Among the problems faced by the Egyptian Auditing Environment is the impairment of auditor's independence because of the shortage of the existence of strong independent professional organizations for promoting the auditing profession and due to other reasons, such as:

1. There is no effective code of professional ethics for accountants and auditors (Wahdan et al., 2005).

2. There is no effective control exists for imposing penalties on accountants and auditors who fail to comply with accounting and auditing standards (i.e. Low litigation rate).

3. The quality of auditing process is influenced by assigning or changing auditors, which may force auditors to comply with top management’s willingness.

Thus, the motivation for the present research comes from a number of reasons. First, the strong interest of regulators and policy makers to acquire evidence from different environments regarding the effect of MAFR on audit quality. Second, the necessity for analyzing the potential benefits and costs that may result from the application of such policy (DeFond & Francis, 2005).

It is important to understand how this regulation affects audit quality before regulators consider additional costs (Winn, 2014). Al-Thuneibat et al. (2011) noted that; “Auditing is a socially phenomenon and therefore policy makers need to evidence from different environments”. The strong debate among regulators in those countries leads policy makers to review back their audit legislations particularly in developing countries. Egypt does not have any regulations demanding mandatory audit firm rotation. Since, there is a controversy surrounding the impact of MAFR on audit quality, the research problem is derived from the researchers’ different points of views regarding whether mandatory audit rotation improves or deteriorates audit quality.

Literature Review

There are a variety of key themes of arguments, both for and against MAFR. The most common arguments are related with the potential impact of mandatory rotation on auditor’s independence, professional skepticism, client specific knowledge, and audit costs. These four dimensions are discussed in the order below:

Auditor’s Independence and Professional Skepticism

Tegasson et al. (2006) argued that auditor independence is a key element for certifying high audit quality. The more the public perceives auditors to be independent from others, the more they believe that auditors are acting their task properly in accordance with moral principles (Cameran et al., 2016).

Auditors are expected to provide unbiased opinion on the financial statements to the interested parties of financial statements. They should be independent from the client they audit, so their audit opinion will not be influenced by any relationship between them and the client. Independence in fact means that the auditor opinion has not been affected by factors that can compromise integrity, professional skepticism, and objectivity of judgment. Thus, independence in fact reflects an auditor state of mind (Raiborn et al., 2006).

Auditor independence is one of the important elements of audit quality (Tepalagul & Lin, 2014) which consists of quality of integrity, objectivity, and impartiality (Said & Khasharmeh, 2014). A wide range of unprofessional relationship between auditors and their clients creates a familiarity threat, such a threat could compromise, or could be perceived to compromise auditors’ objectivity and independence (IESBA- Code of Ethics for Professional Accountants, 2015). This familiarity could create a sympathetic relationship between the client and auditor, restrict the value-added service of the auditor compared to the client, increase the risk and enhance the role of the auditor is becoming too accepting the management’s work which negatively affects audit quality (Acemoglu & Gietzmann, 1997; Barton, 2002; Stefaniak et al., 2009; M. Phil & Adebiyi, 2013; Tepalagul & Lin, 2014). Accordingly, one of the debated factors that can affect auditor’s objectivity and independence is audit firm tenure. Indeed, several studies found a negative correlation between audit firm tenure and audit quality (Palmrose, 1989; Giroux et al., 1995; Dopuch et al., 2001; Al-Thuneibat, 2011). Shockley (1982) indicated that long audit firm tenure may deteriorate auditor’s objectivity and independence. He found that long audit firm tenure can have several negative effects such as; lack of innovation, complacency, and less rigorous audit procedures, which are bad for audit quality.

Jones et al. (2012) suggested a higher quality toward the end of the audit engagement because the departing audit firm would feel a greater accountability for their work when another audit firm will replace them in the coming year. Likewise, Cameran et al. (2016) indicated that audit quality is highest in the last engagement period as the departing audit firm will have no incentive to reduce its independence because it will lose the client anyway and the incoming audit firm might discover any negligence of them.

DeAngelo (1981) assumed that the present audit firms have monetary incentives not to reveal material misstatements in view of holding their client. In addition, she argued that audit firms’ incentive to keep independence declines over time. However, Bates et al. (1982) indicated that the psychological dependence between the audit members and clients is more threatening than the monetary dependence on the client.

Many firms appoint auditors, who are most possibly to agree to management’s views about accounting treatments. Long audit firm tenure can lead to the reality that the auditor prefers the management interests rather than the interest of the shareholders (Arel et al., 2006; Dandago & Zamro, 2013). Moreover, when the firm under audit has been a client for longer periods, the client as a source of a perpetual income which may threaten the audit firm ability to act independently (Nagy, 2005; Arel et al., 2006). M.Phil an Adebiyi (2013) argued that MAFR might help to avoid this treat by limiting the formulation of long audit firm-client relationships that can compromise independence. Therefore, in a MAFR regime the audit firms may have greater incentives to resist management pressures (Dopuch et al., 2001; Ruiz-Barbadillo et al., 2009). Moreover, it can help in stopping opinion shopping practices by restricting its opportunities (Lu & Sivaramakrishnan, 2009; Velte & Stiglbauer, 2012).

Results of prior research indicated that the majority of audit failures involved long audit firm tenure (Walker et al., 2001; George, 2004; Casterella & Johnston, 2013). George (2004) found that audit failures involving long-term relationships are significantly more damaging to investors than failures involving short-term relationships. Therefore, advocates of MAFR implied that MAFR would enhance perceived auditor's independence, reduce the incidence of audit failures through shortens the period of audit firm tenure and increase investors and other stakeholders' confidence in the credibility of financial statements (George, 2004; Jennings et al., 2006; Raiborn et al., 2006; Jackson et al., 2008; Ebimobowei & Keretu, 2011; Casterella & Johnston, 2013; DeFond & Zhang, 2014).

When a client voluntarily changes audit firms, the client can seek an auditor whose accounting and reporting views are more consonant with them (Nagy, 2005). Such voluntarily change would result in a lower level of auditor’s professional skepticism. Chen et al. (2009) argued a positive association between audit quality and auditor’s professional skepticism. Auditors who perform higher degree of professional skepticism are more possibly to discover material misstatements. Proponents of MAFR believed that after the auditor has spent many years with his client, his audit approach will get stale and predictable. This is due to shortage of interest to details, redundancy and repetition from the previous engagement (Arel et al., 2006; Dandago & Zamro, 2013). There is also more likely that the same audit team will be engaged in the following financial year that may rely on their own working papers from the previous years. As a result, this practice will lead auditors to rely on the previous judgments in giving an opinion about the clients’ financial statements of the current year (Dandago & Zamro, 2013). Moreover, this long tenure leads to the tendency to anticipate results rather than evaluating important changes in clients' circumstances (AICPA, 1992). This could result in excessive reliance on a static audit program and performing less audit procedures (Johnson et al., 2002).

Accordingly, auditors should be aware of the need for skepticism. That is because, the increased trust of the management makes the auditor perform fewer audit procedures and does not act with professional skepticism anymore (Mihael et al., 2011). Therefore, auditors should be careful to avoid over-relying on their prior experience and knowledge gained for the same client (Myers et al., 2004). Thus, proponents of audit firm rotation suggested that a new auditor would bring to tolerate greater skepticism and a fresh look that may be lacking in long audit firm tenure. They urged that MAFR increases professional skepticism and enhance audit quality for new audit engagements. The incoming audit firm is expected to bring a ‘fresh look’ to the client’s financial statements and in turn the auditing task becomes more objective (Winn, 2014; Lu & Sivaramakrishnan, 2009; Harris & Whisenant, 2012) that may be lacking in long audit firm tenure. Tagesson et al. (2006) found that public listed companies can gain from MAFR, as it creates greater trust in the audited financial statements, which, in turn will reduce audit risk and lower the cost of capital.

In addition, the audit firm would not view the client as a source of perpetual income (Nagy, 2005). Consequently, it would mitigate the likely of the client to influence the auditor (Vanstraelen, 2000). Auditors also will have greater incentives to resist management pressures, which results in promoting increased independence, skepticism, and objectivity (Dopuch et al., 2001; Ruiz-Barbadillo et al., 2009).

To summarize, the proponents of MAFR found that auditor’s objectivity, independence, and professional skepticism worsen with longer audit firm tenure, which, in turn, hypothesized that auditor’s independence, and professional skepticism will be enhanced after the introduction of mandatory audit firm rotation policy. Thus, the first and second hypothesis can be formulated as follows:

H1: “Mandatory Audit Firm Rotation has a positive impact on auditor’s independence”.

H2: “Mandatory Audit Firm Rotation has a positive impact on Auditor’s Professional Skepticism”.

Client-Specific Knowledge

Some studies revealed results consistent with the notion that auditors want additional time and effort to develop their understanding of client's business, therefore the quality of financial reports is lower within the early years of the audit engagement (Imeokparia, 2014;Tepalagul & Lin, 2014). Therefore, the main argument against MAFR is that, there is an increase in audit quality in the later years of an audit engagement, whereas there is a decrease in audit quality in the initial years of an audit engagement (Cameran et al., 2016).

The decrease in audit quality in earlier years of audit engagement might be due to a lack of knowledge about the client because the incoming audit firms’ understanding of the client's business operations and systems would be limited to only a few years (Carcello& Nagy, 2004; George, 2004; Dandago & Zamro, 2013; Ewelt-Knauer et al., 2013; Lennox et al., 2014).

Opponents of MAFR argued that audit firms gain valuable knowledge about their client overtime and that a newly appointed audit firms may be bad for audit quality (Vanstraelen, 2000). They also assumed that mandatory rotation of audit firms would increase the likelihood of audit failures (Carcello & Nagy, 2004). Therefore, the incoming audit firm may increasingly rely on the client’s estimates and representations in the initial years of audit engagement (Kwon et al., 2014).

Chi (2005) indicated that mandatory rotation can lead to loss of familiarity between the clients and audit firms, that is important for an effective audit process. This loss of familiarity potentially decreases audit effectiveness because auditors have to gain a greater experience in order to develop a greater ability to detect accounting irregularities. Arel et al. (2006) and Jackson et al. (2008) found that audit quality is higher when there is a longer audit firm tenure due to auditors’ cumulative knowledge about the client. Thus, the third hypothesis is developed as follows:

H3: “Mandatory Audit Firm Rotation has a negative impact on auditor- client specific knowledge”.

Audit Costs

Limited researches suggested that MAFR may have more potential disadvantages than advantages (Jones et al., 2012). These issues are related to audit costs and audit quality (PCAOB, 2011; kwon et al, 2014). Opponents of mandatory rotation indicated that audit costs and audit failures risk would increase due to the lack of knowledge and experience of the new audit firm in the initial years of the audit engagement (Kramer et al., 2011; Siregar et al., 2012) ,which drives the decrease in audit quality (Mohrmann, 2015).

Jackson et al. (2008) and Chen et al. (2008) argued that MAFR would increase start-up costs involved with introducing the new incoming audit firm with the client’s procedures, which leads to higher audit costs due to the additional work needed by the new audit firm to gain sufficient knowledge about the client. Mohrmann (2015) implied that if higher audit fees cannot be charged by the new audit firm because of fees and time budget pressures, the audit firm effort might be reduced (Jones et al., 2012). Therefore, requiring firms to be rotated will place higher costs on both the audit firms and the clients (Copley & Doucet, 1993; Jackson et al., 2008). These increased costs will be reflected in a higher audit fees A long audit firm tenure makes it possible for the supporting audit firm to make the audit more efficiently, which results in lower costs for the client (Vanstraelen, 2000). Furthermore, the audited clients argued that MAFR will be time consuming and expensive because of the need to familiarize the incoming audit firm with the entity’s operations, processes, systems, and industry.

Researches indicated that audit firms tend to reduce their audit fees in the early years of engagement to attract clients (commonly referred to as low- balling) (Francies & Simon, 1987; Geiger & Raghunandan, 2002). Cameran et al. (2016) found that the audit fees of the incoming audit firms are discounted by 16 percent, however, the actual audit hours are increasing in the first year of audit engagements. While, subsequent fees are higher and exceed the initial fee discount (Cameran et al., 2016), which is an indication of low-balling practice. Thus, MAFR can reduce the practice of low-balling

GAO (2003) estimated that companies would incur extra auditor selection costs adequate to 17 percent of their first audit fees (GAO, 2003). Similarly, Rezaee et al. (2013) stated that, “while MAFR can promote more auditor independence and thus improve the auditing quality its implementation cost can be too high”. Indeed, it was found that both the client and audit firms suffer great losses in case of audit failures, and that the cost of mandatory rotation implementation would be less than the costs of losing reputation and litigations filled against the audit firm due to audit failures that are the result of decreases in audit quality (Jackson et al., 2008).

Jackson et al. (2008, p.421) stated that, “Morgan Stanley estimates the market capitalization loss of the collapses of WorldCom, Tyco, Quest, Enron and Computer Associates to be $US460 billion.” The auditor rotation costs $1.2 billion per year. Therefore, the costs of poor-quality audits are higher than the potential costs of MAFR. Moreover, Imhoff (2003) expected that shareholders are more willing to incur additional costs of the audit if they guarantee an independent audit. Thus, higher audit costs could be acceptable and are economically justified if audit firm rotation can improve audit quality (Cameran et al., 2016). Chi et al. (2009) indicated that in countries where MAFR is adopted, it is an evidence that regulators considered that the benefits of MAFR to overweigh the costs resulting from its application. Accordingly, the fourth hypothesis can be formulated as follows:

H4: “Mandatory audit firm rotation increases audit costs”.

Research Methodology

The researcher chose to use a questionnaire since it is a suitable instrument for gathering data and contacting respondents who might be difficult to access. Moreover, it is a useful instrument for gathering the perceptions of a potentially large numbers of respondents in a highly economical way enough to allow statistical analysis of the results. The questionnaire is designed and distributed to collect the opinions of a sample of auditors with different years of experience in the audit field about the impact of MAFR on audit quality (AQ). The selected sample includes auditors from different sized auditing firms (Big 4 - Non-Big 4).

The questionnaire is sub-divided into two sections, each of which comprises a number of relevant questions. The first section is designed in a manner that enables the researcher to test the hypotheses. This section consisted of four main parts. The first part contained 8 sub-questions that represent the relationship between MAFR and auditor’s independence. The second part contained 4 sub-questions that represent the relationship between MAFR and professional skepticism. The third part contained 6 sub-questions that present the relationship between MAFR and client-specific knowledge. The last part contained 5 sub-questions that represent the relationship between MAFR and audit costs. The second section of the questionnaire has been designed to know the perceptions of professional auditors regarding the agreement or rejection of the application of MAFR in the Egyptian Environment. It includes the, Exploratory Factor Analysis (EFA) for testing validity, reliability analysis using Cronbach’s alpha, and a one- sample t test for hypotheses testing. After the questionnaires have been distributed and collected, the researcher begins descriptive statistics of the research variables then test the hypotheses of the research. The reliability and validity of the questionnaire have been tested using Exploratory Factor Analysis (EFA) and Cronbach’s Coefficient Alpha statistical test.

Research Sample

The study population included all professional auditors working in all different-sized auditing firms (Big & Non-Big 4). There is no comprehensive list includes the accurate numbers and contact information of the professional auditors at the time of the research. Moreover, it is difficult to get the opinion of each one of them. Accordingly, the study used a non-probability sample to select the participants of the research. The questionnaires were distributed to 450 professional auditors from different-sized auditing firms. Data were collected from February 2016 to August 2016. Of the questionnaires distributed, 246 were returned with a response rate of 54.6%. However, 7 surveys were dropped from the research because of incomplete and inconsistent data. Therefore, the final sample includes 239 questionnaires. Table 1 presents the sample characteristics.

This table refers to that the majority are auditors from the Big (4) auditing firms representing 59.5%. It also shows that 33.1% of respondents are seniors, 30% are staff members, 19.5% are audit managers, 13.6% are audit office’s owners, and 3.8% are audit partners.

Descriptive Analysis

Table 2 shows Descriptive Analysis for each of the variables. According to item coding, the researcher used Ind., Skep, Know., and cost to refer to each sub-question of auditor’s independence, auditor’s professional skepticism, auditor client-specific knowledge, and audit costs variable respectively. The analysis refers to that the means vary from 1.81 to 4.43. Also, STD is located between 0.592 to 1.135 which implies that there's associate agreement. According to the variances are low because of the standard deviation is a smaller amount than half the connected mean. The maximum mean is 4.43 indicating that respondents agree that long audit firm tenure increases the audit firm’s knowledge about the client industry because the audit firms gain valuable knowledge overtime through the client. The minimum mean is 1.81 indicating that the respondents disagree which means that long audit firm tenure strengthens the personal relationship between the client and audit firm. In addition, the respondents prefer the application of mandatory audit firm rotation policy (mean = 7.74). Kline (2015) argued that it is common to infraction the normality assumption especially in social science; therefore, there is no series problem to test the hypotheses in case of the skewness and kurtosis of each item ranges from ±3 and Kurtosis within range ±10.

Exploratory Factor Analysis (EFA)

The researcher used EFA to assign each item on its construct.

EFA Results of Auditor’s Independence

Table 3 shows that KMO value is 0.755 (over 0.6) which is sufficient and also Bartlett's test is significant on a confidence level 95% (P < 0.05). The cumulative variance is .54377 (less than 0.6) (hair et al., 2010) and the eight constructs are divided into two components (the two components had an eigenvalue greater than 1). The rotated component matrix is the key output of the principal component analysis. It places each construct to where it belongs which is component 1, component 2… Etc. Table (3) also shows the loadings of the eight constructs on the two components extracted. Looking at the table above, Ind. 5, Ind. 6, Ind. 3, Ind. 4, and Ind. 8 are loaded on component 1. Ind. 1, Ind. 2, and Ind. 7 are loaded on component 2.

Table 4 shows that KMO value is 0. 642 (over 0.6) which is sufficient, Bartlett's test is significant, the cumulative variance is .5354 (less than 0.6, is some instances may happens (hair et al., 2010), the four constructs are loaded into one components (had eigenvalue greater than 1), and there is no component score coefficient matrix.

EFA Results of Auditor Client Knowledge

Table 5 shows that KMO value is 0.73 (over 0.6) which is sufficient, Bartlett's test is significant, according to eigenvalue threshold, the cumulative variance is .653 (higher than 0.6), and there are no cross loadings in component score coefficient matrix.

The six constructs are loaded into two components (had an eigenvalue greater than 1). Looking at table 5, Know1, Know2, and Know3 are loaded on component 1. Know5, Know6, and Know4 are loaded on component two.

EFA Results of Audit Costs

Table 6 shows that KMO value is 0. 717 (over 0.6) which is sufficient, Bartlett's test is significant, according to eigenvalue threshold, the cumulative variance is .45271 (less than 0.6, is some instances may happens (hair et al., 2010), the fifth constructs are loaded into one components (had eigenvalue greater than 1, and there is no component coefficient matrix.

Reliability Analysis

Table 7 shows the reliability results based on Cronbach's alpha coefficients.

This table above shows that all elements of the questionnaire can be reliable to conduct the hypotheses (threshold 0.6) (Hair et al., 2010).

Hypothesis Testing

The researcher separately examined the effects of MAFR on auditor’s independence, professional skepticism, client- specific knowledge, and audit costs to test the net of these possible effects on audit quality

Testing the First Hypothesis

The first hypothesis states that “Mandatory Audit Firm Rotation has a positive impact on Auditor’s Independence”. Consistent with H1, auditors agree with the statement that MAFR results in enhancing auditor’s independence and hence improve audit quality as indicated by the means and p-values in Table 8 (P value < 0.01). This result is largely in agreements with the results of prior researches on the relationship between MAFR and auditor independence (Depuch, 2001; Daniels & Booker, 2011; Ebimobowei & Keretu, 2011; Imeokparia, 2014; Said & khasharmeh, 2014). They found that MAFR improves audit quality by enhancing auditor’s independence. Also, they argued that when audit firms are rotated in a regular basis, it will help to avert cases in which audit firms are becoming frequent with a specific client. Therefore, the first hypothesis is accepted.

Testing the Second Hypothesis

The second hypothesis states that “Mandatory Audit Firm Rotation has a positive impact on Auditor’s Professional Skepticism”. In support of H2, auditors’ responses show that they believe MAFR to positively affect auditors’ professional skepticism, as indicated in Table 9. It is consistent with the results of (Depuch, 2001; Daniels & Booker, 2011; Ebimobowei & Keretu, 2011; Imeokparia, 2014; Said & khasharmeh, 2014). They found the introduction of audit firm rotation is considered as a useful mean of increasing auditors’ professional skepticism. Therefore, the second hypothesis is accepted.

Testing the Third Hypothesis

The third hypothesis states that “Mandatory Audit Firm Rotation has a Negative Impact on Client-Specific Knowledge”. Consistent with H3, auditors come to an agreement that MAFR decrease client- specific knowledge, as indicated in Table 10 (P value ? 0.01). They believe that audit quality is significantly affected by the lack of client-specific knowledge due to MAFR. Therefore, the third hypothesis is accepted.

The Fourth Hypothesis

The Fourth Hypothesis states that “Mandatory Audit Firm Rotation increases Audit Costs”. Consistent with H4, auditors adopted that MAFR increases audit costs, as indicated in Table 11 (p ? 0.01). Therefore, the fourth hypothesis is accepted. Auditors believe that audit costs will have a negative effect on audit quality even if audit firm rotation is mandatory. Porter et al. (2008) argued that the costs associated with MAFR are significantly less than the costs associated with audit failures. Moreover, Okaro & Okafor (2013) found that investors have lost several billions of dollars as a result of clients that falsified their accounts. Thus, the costs of MAFR would be less than the costs of losing reputation and litigations filled against the audit firm due to audit failures (Jackson et al., 2008).

Discussion of the Findings

For the first hypothesis which tested whether MAFR has a positive impact on auditor’s independence. This hypothesis is accepted. This result is agreement with the results of (Depuch, 2001; Daniels & Booker, 2011; Ebimobowei & Keretu, 2011; Imeokparia, 2014; Said & khasharmeh, 2014; Cameran et al., 2016). They argued that the lower the degree of independence of the auditor lead to decrease the quality of audit services. Davis et al. (2009), Coyle (2010), Lennox et al. (2014), Winn (2014), and Cameran et al. (2016) indicated that audit quality is highest in the last engagement period as the departing audit firm will have no incentives to reduce its independence because it will lose the client anyway and the incoming audit firm might discover any negligence of them. Additionally, auditors will be more concerned about their reputation (Ruiz-Barbadillo et al., 2009).

This result is contradicting to the results of Kaplan & Mauldin (2008) which found that MAFR does not confirm the independence in occurrence through non-professional investors. In addition, Ruiz-Barbadillo et al. (2009) found no evidence that MAFR is related with a higher probability of issuing going-concern views (a proxy for auditor independence). They indicated that auditors’ incentives to protect their reputation have a positive impact on the probability of issuing going-concern views. Danials & Booker (2011) found a mixed result. They found that loan officers perceive that MAFR support the conception of auditor independence but doesn't support audit quality.

For the second hypothesis, which tested whether audit firm rotation has a positive impact on auditor’s professional skepticism. This result is consistent with the results of (Depuch, 2001; Daniels & Booker, 2011; Ebimobowei & Keretu, 2011; Imeokparia, 2014; Said & khasharmeh, 2014). They found the introduction of MAFR is considered as a useful mean of increasing auditors’ professional skepticism. When a client voluntarily changes audit firms, the client can seek an auditor whose accounting and reporting views are more consonant with them (Nagy, 2005).

Such voluntarily change would result in a lower level of auditor’s professional skepticism. Chen et al. (2009) documented a positive relationship between auditor’s professional skepticism and audit quality. Proponents of MAFR believed that after the auditor has spent many years with his client, his audit approach will get stale and predictable. This is due to lack of attention to details, redundancy and repetition from the earlier engagement (Arel et al., 2006; Dandago & Zamro, 2013). Proponents argued that MAFR can provide a powerful and an effective peer review effect, as the departing audit firms will be encouraged to raise their effort at the last of audit engagement (Ebimobowei & Keretu, 2011). That is because they know that their work will be reviewed by the new incoming audit firms that will take over the audit in the following year. Opponents argued that MAFR increases the likelihood of audit failures (Geiger & Raghunandan, 2002; Carcello & Nagy, 2004), because the incoming audit firm will place greater depend on the management's estimates and representation audit engagement early, which results in lower audit quality (Barton, 2002; Myers et al., 2003).

For the third hypothesis which tested whether MAFR has a negative impact on auditor client-specific knowledge. This hypothesis is accepted. Chi (2005) indicated that MAFR can lead to a loss of familiarity between the clients and audit firms, that is important for an effective audit process. This loss of familiarity potentially mitigates audit effectiveness. Arel et al. (2006) and Jackson et al. (2008) found that audit quality is higher when there is a longer audit firm tenure. Opponents of MAFR assumed that mandatory rotation of audit firms would increase the likelihood of audit failures (Carcello & Nagy, 2004). These failures may be due to lack of sufficient auditor’s experience with the client to observe unusual changes in the client’s environment (Kwon et al., 2014). Industry specialization can offset the negative effect of mandatory audit firm rotation on client specific knowledge. This view can be supported by the findings of Elder et al. (2015) as they indicated that adoption of MAFR policy may be useful specially in markets where the presence of specialist audit firm.

For the fourth hypothesis which tested whether MAFR increases audit costs. This result is accepted. Porter et al. (2008) and Okaro & Okafor (2013) found that investors have lost several billions of dollars as a result of clients that falsified their accounts. Thus, the costs of mandatory rotation of audit firms would be less than the costs of losing reputation and litigations filled against the audit firm due to audit failures (Jackson et al., 2008).

Finally, the research findings showed there is a positive relationship between MAFR and audit quality. The researcher found that the mandatory audit firm rotation enhances auditor’s independence and professional skepticism. However, the findings indicated that MAFR has a negative impact on client-specific knowledge. Industry specialization can offset the negative effect of MAFR on client-specific knowledge. Auditors perceived that MAFR increases audit costs. Even though the MAFR of audit firms costs more, this policy increases the independence of auditors and audit quality which is relatively more than the costs.

Conclusion

The purpose of the present research is to explore the perceptions of professional auditors about the impact of MAFR on audit quality and whether this policy should be introduced in the Egyptian environment. In order to achieve the main objective of the research and knowing the perceptions concerning the effect of MAFR on audit quality, the researcher used questionnaires. The results indicated that proponents of MAFR believed an increase in auditor’s independence and professional skepticism in a mandatory audit firm rotation regime, while opponents suggested that mandatory audit firm rotation leads to a loss of auditor’s knowledge about the client and increases audit costs. The present research separately examined the effects of MAFR on auditor’s independence, professional skepticism, client-specific knowledge, and audit costs and tests for the net of these potential impact on audit quality.

The research findings showed that auditors indicated that there is a positive relationship between MAFR and audit quality. In addition, it is found that the introduction of MAFR is considered a useful mean of adding to the independence and professional skepticism of auditors. Accordingly, legislators are advised to take this policy into consideration. However, the findings indicated that there is a negative relationship between MAFR and client-specific knowledge. Low (2004), Reichel & Wang (2010), Elder et al. (2015), and Hegazy et al. (2015) found that industry specialization improves the quality of audit services. Industry specialization refers to industry- specific knowledge accumulated from serving clients in the same industry. Thus, industry specialization can offset the negative impact of MAFR on client- specific knowledge. This view can be supported by the findings of Elder et al. (2015) as; they indicated that adoption of MAFR policy may be useful specially in markets where specialist firms exist. In addition, Lim& Tan (2010) found that auditors who are specialized in a specific industry begin the audit of a new client with superior knowledge of the industry which leads to better understanding of clients’ business, operations, and risks and hence improves audit quality.

Finally, auditors perceived that MAFR increases audit costs. Even though the MAFR of audit firms costs more, this policy increases the independence of auditors and audit quality which is relatively more than the costs. The costs of MAFR of audit firms would be less than the costs of losing reputation and litigations filled against the audit firm due to audit failures (Jackson et al., 2008). Consequently, external users of financial statements are more willing to incur additional costs of the audit if it guarantees them of an independent audit. The period of MAFR should be established with great care given the delicate balance between client-specific knowledge and independence issues. The researcher suggests that the rotation period should be five years (with a cooling-off period of more than 3 years) as the majority of auditors suggest that the five-year MAFR requirement may in fact lead to effective audit.

Suggestions for Future Research

This section offers some ideas for future research as follows:

1. The present research investigates the effect of mandatory audit firm rotation on audit quality using four based indicators which are auditor’s independence, professional skepticism, audit firm-client specific knowledge, and audit costs. Hence, investigating this effect on other indicators of audit quality would be a good opportunity for further research.

2. The present research focused only on the perceptions of auditors. Thus, further research can investigate the perceptions of other interested bodies such as investors and legislators.

3. Last, but by no means least, conducting a comparative study about the impact of mandatory audit firm rotation and audit quality in a developed country and a developing one or even between two developing countries and determining the differences and the reasons behind that would be interesting.

The Research Limitations

The following points represent the limitations of the present research:

1. The present research is sampled only professional auditors working in different sized auditing firms operating in Egypt and excluded auditors working in the Central Auditing Organization (CAO) as they have different regulations related to public sector companies’ audit.

2. The present research findings are based on the perceptions of Egyptian auditors so the findings of the research cannot be generalized among all developing countries as each one has its own culture, economic, and political conditions, which could affect this relation differently.

3. The impact of the mandatory audit rotation is measured through perceived not actual audit quality, since there is no available data as mandatory audit firm rotation still not adopted in Egypt.

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