The Propensity for Mandatory Audit Rotation and Its Impact on Earnings Management: An Evidence from the United Kingdom

Abstract

In the recent years, the frequent occurrences of massive accounting scandals related to earnings management have provoked alarm in the financial market about the accuracy of financial reporting statements as well as the credibility of external auditors. Therefore, Mandatory Audit Rotation (MAR) rules have been enacted in many countries in order to tackle these enormous accounting frauds. In the United Kingdom (UK), since the MAR rule introduced in 2012, there have not any researchers investigating the effectiveness of this rule. Hence, this study is undertaken to examine the effectiveness and the necessity of the latest MAR rule in the UK by testing the influence of audit rotation activities and audit tenure on earnings management of companies in the FTSE 350 Index. Practical implications of this study not only prove that FTSE 350 companies should be required to shorten their audit tenure by rotating their audit engagement more often in order to decline the degree of earnings management, but they also strengthen support for the essentiality of MAR legislations in the UK when showing that longer audit tenure actually leads to more earnings management of FTSE 350 companies.