An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Dae - Hee Yoon
Yale School of Management

Abstract: The old debate about whether mandatory rotation can remedy shortcomings of the audit market has arisen again after a series of accounting scandals. The main impetus for mandatory rotation is the prospect of greater independence. In this paper, I suggest that mandatory rotation has an additional benefit rooted in risk sharing among auditors. As audit risk is influenced by both detection and client risk, regular rotation of clients enables auditors to intertemporally diversify the risks they face. However, since specialization offers natural learning benefits, there is also a downside to rotation. This downside can be overcome by information sharing between predecessor and incoming auditors. Information sharing improves the incoming auditor's information set and the risk-sharing benefit of mandatory rotation are even more emphasized than before.

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