Network Analysis of Audit Partner Rotation

Abstract

Although mandatory audit partner rotation has become prevalent worldwide, prior empirical research seldom considers how the successor partners are identified and the economic consequences of different rotation strategies. We examine the importance of internal networks to the selection of successor partners and the underlying incentives in the selection process in China, which affords an opportune testing ground for analyzing our research questions. We find that candidate partners who are familiar with the incumbents—evident in prior teamwork experience—are more likely to be selected as successors. This phenomenon is more pronounced when the audit engagement is more complex, client-specific knowledge is not readily available to the succeeding partner, and the engagement is more attractive to the audit firm. These results are consistent with auditors’ incentive to facilitate information transfer and maintain client satisfaction after the transition. Reinforcing this interpretation, we find that successor–incumbent familiarity is associated with better post-rotation audit-reporting quality and less frequent client defections without undermining the quality of the audited financial statements. Enriching our understanding of the production of audit services in audit firms, our analysis contributes to the public policy discourse on partner rotation.

Keywords: Network; Audit partner rotation; Client retention; Information transfer

JEL Classification: M42; D85; M48