This article summarizes our recent study (Fontaine, Khemakhem, and Herda 2016), which investigates audit committee (AC) members' perspectives on mandatory audit firm rotation (MAFR), mandatory audit partner rotation, ways in which AC members monitor auditor independence, and the costs associated with changing audit firms. We conduct in-person interviews with AC members in Canada to explore our research questions. Our findings reveal that AC members view MAFR as an unnecessary threat to their shareholder-granted authority to make audit firm appointment decisions, and believe their professional judgment and observations are the most effective means of ensuring auditor independence. We explain our findings using self-determination theory. Deep insight into the perspectives of AC members, attained by face-to-face interviews and guaranteed anonymity, should interest audit firms and regulators.

A commonly recommended solution to guard against the loss of auditor independence is mandatory audit firm rotation (MAFR) (Reid and Carcello 2017). MAFR has received a significant amount of attention due in part to a Public Company Accounting Oversight Board (PCAOB) concept release on audit firm rotation (PCAOB 2011). Although MAFR in the U.S. is unlikely, it is being implemented in Europe (Tysiac 2014). Audit committee (AC) members play a critical role in corporate governance as they are responsible for the appointment, compensation, and oversight of external auditors, and could choose to voluntarily implement a firm rotation program. Explanations for AC opposition to MAFR have hitherto been limited to information contained in formal signed comment letters sent to the PCAOB. The present study consists of interviews primarily designed to deepen our understanding of the underlying reasons behind AC members' perspectives on MAFR.

Most academic research on MAFR provides little evidence that it is effective in improving audit quality (Stefaniak, Robertson, and Houston 2009). The Canadian setting is somewhat unique in that MAFR was required for financial institutions until 1991 when it was abandoned due to a lack of cost effectiveness (GAO 2003). Recently, the Canadian Public Accountability Board (CPAB) and Chartered Professional Accountants of Canada issued a report outlining how audit quality could be enhanced (CPAB 2013). They conclude that MAFR would not improve auditor skepticism and argue that new auditors may not have satisfactory client- and industry-specific knowledge to conduct a quality audit. The groups contend that switching audit firms should be an informed decision led by the AC. Current rules on audit partner rotation and AC responsibilities in Canada are similar to U.S. policies. Many companies in Canada are cross-listed on U.S. exchanges and are therefore subject to SEC regulations.

Prior to this study, what we knew about AC member perspectives on MAFR was generally limited to information found in formal signed comment letters sent to the PCAOB in response to a concept release (PCAOB 2011). An overwhelming majority of the 238 comment letters submitted by AC members oppose MAFR, citing higher audit costs and increased management and AC time in bringing a new audit firm up to speed on their company (EY 2012). Although these comment letters provide some insight into AC views on MAFR, signed two-page letters do not provide the depth of perspective that in-person interviews (with guaranteed anonymity) elicit. Accordingly, we ask research questions soliciting AC members' perspectives on (1) MAFR, (2) mandatory audit partner rotation, (3) ways in which AC members monitor auditor independence, and (4) the costs associated with changing audit firms.

To address our exploratory research questions, we conducted 19 interviews with AC members of Canadian publicly listed corporations in Quebec or Ontario. We used professional contacts and referrals to gain access to participants.1 Thirteen participants (68 percent) are AC chairs. Two interviewers (authors) were present at each interview. One author led the interview and another took notes and ensured that our open-ended interview guide was being followed. The average interview lasted 1 hour 18 minutes, ranging from a minimum of 41 minutes to a maximum of 2 hours 17 minutes. The interviews were audio recorded for subsequent transcription. We analyzed and coded each transcription to reveal underlying themes. Data were coded into major categories by two authors independently and any discrepancies were resolved by discussion and negotiated consensus.

All 19 AC members interviewed are adamantly opposed to MAFR. Participants claim that the AC has the sole authority to make switching decisions and they wish to retain and exercise this right only if and when they believe a change is necessary and in the best interest of the company. MAFR was perceived as an unwelcome threat to the AC's authority and autonomy bestowed upon them by shareholders. An illustrative excerpt follows:

MAFR is forcing a situation. I would like to remain responsible regarding the relationship that exists as the chair of the AC. I would like to keep my responsibility and my authority and I say this with a great deal of humility. But to exercise a role you need a little bit of power to choose my audit partner, to assure that the relationship between my auditor and the partner that signs the financial statements and the CFO is conducted in the best way to ensure independence. And this I want to keep.

When asked about audit partner rotation, the mood changes. Most participants feel that a new set of eyes promotes professional skepticism and generally appreciate the way in which audit firms transition lead partners, as this process seems to effectively transfer knowledge and preserve the management-auditor relationship. A representative excerpt follows:

From a practical perspective, I'm not opposed to it. For independence, it's always good to have a reality check. It could get too cozy and it would be hard for the auditor to maintain his independence because you can push on as a client … say I want to disclose this way … I want this policy in place. If they (audit firm) manage the transition properly it's less onerous on me because at least I can transition that relationship to the new guy. I'm still going to call the old partner if I have a good relationship and I'm going to ask him high-level accounting questions.

Participants emphasize the importance of creating an environment in which both management and auditors know that they can trust the AC with information. Some participants conceptualize their relationships with external auditors and company management as triangular. We illustrate this conceptualization in Figure 1.

FIGURE 1

Conceptual Model of the Relationships between the Audit Committee, Financial Management, and External Auditor

Source: Fontaine et al. (2016).

FIGURE 1

Conceptual Model of the Relationships between the Audit Committee, Financial Management, and External Auditor

Source: Fontaine et al. (2016).

Close modal

AC chairs set the tone of these relationships through openness and availability. Participants underscore that both the auditor and financial management should know that it is easy for them to contact the chair, and emphasize that the auditor and financial management must be independent but also must work together cooperatively:

Regarding informal meetings … each chair has their own method … my way is the following. I say to the CFO and external auditor, I say to them I am available anytime you want to talk and I am easy to reach. Secondly, if there is something out of the ordinary, before the meeting with the AC I want you to call me to meet. The people need to feel at ease.

Interestingly, the AC's professional judgment in assessing independence is the most-cited safeguard against impaired auditor independence. This response theme is cited more frequently than other safeguards such as mandatory partner rotation and CPAB or PCAOB inspections. This excerpt illustrates how one participant identified a potential independence issue and took action:

You start with the assumption that they are independent to each other … you look for indicators that they are not, that they are actually too close. So one of the issues over here was that I set a lunch to meet a new audit partner and she phoned to cancel the lunch the morning of the lunch and she said she couldn't have lunch because she hadn't cleared it with the CFO. That was her last day on the file. You don't clear my lunch with the CFO. I am the chair of the AC. This happened and I said goodbye. She's not independent.

Participants indicate that the most significant cost associated with changing auditors is the substantial time and effort involved in the tendering process and in bringing a new auditor up to speed with client- and industry-specific knowledge. However, most participants claim these switching costs would not influence their decision to change audit firms.

The principal topic of this study is MAFR. The interview results indicate that all participants adamantly oppose MAFR. This finding can be explained using self-determination theory. Self-determination theory (Deci and Ryan 1985, 2000) specifies that autonomy is an innate psychological need that is enhanced by intrinsic motivators such as the ability to influence. Using this theory, Boivie, Graffin, and Pollock (2012) find that the ability to influence organizational outcomes is a significant motivator for AC members. As such, self-determination theory serves as a useful framework for interpreting our results.

The interviews reveal that the desire for autonomy and the ability to influence are very important to AC members and likely shape their views on MAFR. Illustrative excerpts from participants include “each time the government intervenes it takes away autonomy,” and “I would like to keep my responsibility and my authority.” It appears AC members view MAFR as a threat to their autonomy and ability to influence audit firm appointment decisions, and are therefore opposed to it.

Understanding the attitudes and behavior of AC members is essential, as these individuals are empowered to make audit firm selection decisions and could choose to voluntarily implement an audit firm rotation program. Our study's deep insight into AC members' perspectives on MAFR should interest audit firms and regulators. Based on a review of 238 formal comment letters from AC members to the PCAOB, increased cost was the most-cited reason for AC members' opposition to MAFR (EY 2012). However, cost is certainly not the most-cited reason in our interviews. Participants are quick to assert that the AC itself is better equipped to ensure auditor independence compared to a firm rotation rule, and express a desire to keep their authority and autonomy in this capacity. In fact, most participants do not even mention costs until specific questions on switching costs are broached later in the interviews. Costs outweighing benefits almost seems like a boilerplate response. Our interviews reveal the fundamental reason why AC members oppose MAFR—they wish to retain their autonomous ability to influence audit firm appointment decisions.

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1

Our interviewee group is a convenience-based sample. Convenience samples have been used in prior interview studies with audit committee members (e.g., Archambeault, DeZoort, and Holt 2008; Beasley, Carcello, Hermanson, and Neal 2009). Nevertheless, it is possible that randomly selected audit committee members may respond differently to our research questions.

Author notes

Editor's note: Accepted by J. Gregory Jenkins.