The Effects of Mandatory Auditor Rotation on External Audit Quality (Evidence from Luxembourg)

As a response to several international accounting scandals, which have occurred over the past decades, scepticism has arisen regarding the quality of the services provided by external auditors. A certain degree of the public trust in the quality of audit services has been lost and external auditors have been put under the spotlight, especially regarding their competence to remain independent from their client during the realisation of their professional obligations. This master thesis entitled “The Effects of Mandatory Auditor Rotation on External Audit Quality” aims at observing how the European response, represented by the implementation of Directive 2014/56/EU on statutory audits of annual accounts and consolidated accounts and Regulation No 537/2014 of the European Parliament and of the Council of 16 April 2014 have impacted the quality of audit. This reform introduced mandatory auditor rotation in the European regulatory framework, with the goal to further enhance audit quality by limiting the maximum legal audit tenure between a public interest entity and its appointed auditor. The analysis conducted during this thesis uses earnings quality, and more specifically the variation in the levels of discretionary accruals, as a measure and proxy of audit quality. Due to the intention of this thesis to draw evidence from Luxembourg, the population used for the creation of the dataset of this analysis are public interest entities listed on the Luxembourg Stock Exchange’s regulated market. The results of the regression analysis based on this specific dataset suggest that longer audit tenures seem to be significant and improve the quality of the audit, which translates into an argument against Mandatory Auditor Rotation, however, this effect is expected to be decreasing once the tenure reaches a certain number of years, point at which the effects on audit quality will revert. Furthermore, no conclusion could be drawn from the auditor rotation variable itself, but by using a methodology of regression through the origin, by eliminating the intercept of the regression model, audit rotation was significant and suggested a decrease in audit quality. In conclusion, the results of this thesis are in line with previous research in the field of audit quality and will hopefully provide further insight in this research field, especially for the Grand-Duchy of Luxembourg.