Audit firm rotation, audit fees and audit quality: The experience of Italian public companies

This paper examines some of the costs and benefits associated with audit firm rotation usingdata from Italy, where mandatory audit firm rotation has been in place since 1975. Previousstudies in this area did not find consistent evidence of an association between audit qualityand voluntary or mandatory audit firm rotation. A recent paper, examining Italian publiccompanies audited by a Big 4 audit firm, uses proprietary data and finds no statisticallysignificant association between audit firm rotation and audit quality. In this study, we hand-collect publicly available data for a larger sample of Italian public companies audited by aBig 4 and non-Big 4 audit firm (1583 firm-year observations) over a longer time horizon(1998–2011). We find that audit quality, proxied by two different measures of earningsmanagement, improves following audit firm rotation for companies audited by a non-Big 4audit firm. Additionally, we examine whether higher audit fees are associated with auditfirm rotation. Our results indicate that following audit firm rotation, the total amount offees paid to the auditor was lower for companies audited by a Big 4 and unchanged forcompanies audited by a non-Big 4 audit firm. The results of this study should be of interest toEuropean and U.S. legislators who are currently, or have recently, considered implementingmandatory audit firm rotation in order to improve financial reporting quality.