Documenti di Didattica
Documenti di Professioni
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Henry Laurion
henry_laurion@haas.berkeley.edu
Alastair Lawrence*
lawrence@haas.berkeley.edu
James Ryans
jryans@london.edu
June 2016
KEYWORDS: U.S. audit partner rotations; fresh look; restatements; valuation allowances and
reserves; write-downs; special items.
DATA AVAILABILITY: Data are publicly available from sources identified in the article.
We have received valuable comments and suggestions from Clive Lennox (Editor), two anonymous reviewers, Hailey Ballew,
Nicole Bastian Johnson, Anne Beatty, Sam Bonsall, Zhan Bozanic, Agnes Cheng, Hans Christensen, Joshua Cutler, Angela
Davis, Richard Dietrich, Sunil Dutta, David Guenther, Wenli Huang, Bret Johnson, Yaniv Konchitchki, Miguel Minutti-Meza,
Alexander Nezlobin, James Ohlson, Kyle Peterson, Darren Roulstone, Terry Shevlin (2016 Interchange Discussant), Xiaoli
Tian, Andrew Van Buskirk, David Williams, Ryan Wilson, Kaishu Wu, Helen Zhang, Xiao-Jun Zhang, and seminar
participants at Hong Kong Polytechnic University, The Ohio State University, University of California at Berkeley, University
of Oregon, 2016 AAA Western Region Meeting Doctoral Student Faculty Interchange (Seattle), and audit partners at all the
Big 4 accounting firms. We thank Stephen Sloan for the helpful research assistance.
*Corresponding author.
ABSTRACT: We investigate the effects of audit partner rotation among U.S. publicly listed
firms, utilizing the fact that audit partners are periodically copied by name in public
correspondence between issuers and the SEC. Relative to non-rotation firms, we find no
We also find an increase in deferred tax valuation allowances. Overall, the results provide some
evidence suggesting that U.S. partner rotations support a fresh look at the audit engagement.
In this study we investigate the effects of audit partner rotation among U.S. publicly
listed firms by means of the fact that audit partners are periodically copied by name in public
correspondence between issuers and the Securities and Exchange Commission (SEC). For over
35 years partner rotation has been a component of quality control processes for a vast majority
of the accounting firms that audit SEC registrants (SEC 2003). Audit partner rotation is
intended to maintain auditor independence and bring a fresh look to audit engagements, while
maintaining continuity and overall audit quality (e.g., SEC 2003). Such rotations have generally
reflected compromises in place of full audit firm rotations, which involve significantly greater
switching costs. Regulators state that partner rotation requirements must balance the need to
achieve a fresh look and independence against the need for the audit engagement team to be
subject to rotation and how long a partner should remain on the engagement prior to rotating.
partner rotation with the requirement that the lead audit partner rotate off an audit engagement
of SEC registrants after seven years. Then, prior to returning, the partner must take a two-year
time out, also known as a cooling off period (AICPA 1978). The Sarbanes-Oxley Act of
2002 (SOX) further requires that both the lead partner and the concurring partner (reviewing
partner) rotate off the audit engagement of SEC registrants after five years (SOX 2002).
Furthermore, the SEC adopted rules in 2003, requiring a five-year time out period for both lead
and concurring partners (SEC 2003). Thus, under current U.S. standards, lead audit partners
must rotate off an audit engagement for an SEC registrant after five years and then sit out for
Audit partner rotation addresses a concern that long-term relationships between audit
partners and clients can compromise partner objectivity and independence. Specifically,
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partners are more likely to lose independence and acquiesce to client positions as they become
increasingly familiar with management (e.g., Bamber and Iyer 2007). Partners may also be
reluctant to realize restatements, as this can have a detrimental effect on compensation (e.g.,
Hennes, Leone, and Miller 2014). New partners may help counter the development of such
familiarity and bring a renewed sense of skepticism as well as additional insights and expertise
to the engagement. While incoming audit partners might be reluctant to call attention to a
fellow partners past mistakes, litigation risk will increase for incoming partners if they do not
correct errors and adjust unreasonable assumptions. There may also be costs to partner rotation,
including management influence on the selection of new partners (Cohen, Krishnamoorthy, and
Wright 2010). Additionally, the new partner may be less informed about the client and have
Examining the empirical effectiveness of U.S. partner rotation is difficult because audit
partner identities, and therefore rotations, are not disclosed in U.S. audit reports (PCAOB
2013). Nevertheless, the limited U.S. evidence generally indicates that partner rotation
decreases audit quality as a result of the loss of client-specific knowledge and industry
expertise. In international settings where audit partner identities are publicly disclosed (e.g.,
Australia, China, Germany, and Taiwan), studies have provided mixed evidence concerning the
effects of partner rotation (e.g., Carey and Simnett 2006; Chi and Huang 2005; Chen, Lin, and
Lin 2008; Chi, Huang, Liao, and Xie 2009; Gold, Lindscheid, Pott, and Watrin, 2012;
Azizkhani, Monroe, and Shailer 2012; Firth, Rui, and Wu 2012; Lennox, Wu, and Zhang
2014).
To identify partner rotations, we utilize SEC comment letters, which are publicly
disclosed correspondences between issuers and the SEC. SOX requires that the SECs Division
of Corporation Finance (DCF) review each issuers annual report and related filings at least
once every three years. In practice, reviews occur on average every two years (SEC 2015).
2
When issuers respond to the DCFs questions in comment letters, they often copy a variety of
parties in their response letters, including legal counsel, SEC staff, and audit partners.
Consequently, we identify a sample of partner rotations when different audit partners are
copied on comment letters issued in consecutive years and employ this approach to construct
our primary sample of 205 U.S. partner rotations at 189 SEC public companies from 2006 to
2014. 1
Bamber and Bamber (2009) emphasize that the effects of partner rotation are likely to
be modest, and in order to detect an economically material effect, should one exist, empirical
tests must be well-specified. Additionally, they note the importance of analyzing changes in
audit quality concurrent with partner rotations rather than tenure, and using sharper measures of
audit quality (rather than discretionary accruals and earnings response coefficients). In
accordance with their recommendation, we specify financial reporting measures that are likely
to be influenced by the incoming audit partner and conduct our tests in periods surrounding
partner rotations.
misstatements), write-downs, and special items, as well as changes in valuation allowances and
then the frequency of restatement discoveries and announcements should increase under the
new partner. Additionally, if the incoming partner provides a more thorough audit, then the
frequency of misstatements may decrease under the new partner. Moreover, a significant
impairments, special items, and accruals related to allowances. If an outgoing audit partner has
not required asset impairments or allowance increases when such measures are suggested by
1
We utilize consecutive years to mean either two years in a row or with a one-year gap in between.
3
GAAP, then an incoming partner, with greater independence and the ability to identify and
and disclosing financial reporting issues are the two key components of audit quality as defined
measures in an attempt to capture circumstances where the new audit partner both identifies
measures for partner rotation firms before and after treatment against a control group of non-
rotating firms. The findings provide some evidence suggesting that partner rotation supports a
fresh look. Specifically, relative to non-rotation firms, we find that there is no change in the
frequency of misstatements (i.e., restated periods) following the partner rotation; however,
restatement discoveries and restatement announcements display relative increases of 4.6 and
3.8 percentage points, respectively. The restatement discoveries and announcements for partner
change firms primarily relate to related party or subsidiary issues, accounting for income taxes,
cash flow statement classification errors, and fixed asset impairment issues. Although, we find
that total allowances increase by 0.8 percent of assets following a partner change, this finding is
a weak result as it is primarily driven by the increase in the deferred tax asset valuation
increases in write-downs and negative special items, we find some evidence of decreases in
While this study is one of the first to directly examine U.S. partner rotations using
publicly available audit partner data, it has limitations. First, we are only able to observe
partner rotation (for treatment firms) and non-rotation (for control firms) when partner names
and non-rotations for 568 U.S. public firms, and this sample reflects firms that are larger and
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more economically significant than average. Apart from firm size, we find that the main
fundamentals and industry composition of our sample are fairly similar to the Compustat
population. Second, several of our findings have marginal statistical significance which could
reflect the small available sample sizes or indicate that the effects of a partner rotation are fairly
modest.
Third, the periodic frequency of partner identification in our setting results in the
inability to identify whether a partner rotation is voluntary or mandatory, which raises concerns
as to whether the rotation was requested by the client due to a conflict or was a damage control
mitigate concerns that the comment letters resulted in the partner rotation, we examine all our
restatements to ensure that the restatement was not related to an issue raised in the SEC
comment letters. Additionally, we discussed the rate of voluntary rotations with audit partners
from all four Big 4 firms, who indicated that few partner rotations in the U.S. are voluntary,
noting that audit firms prefer to make five-year commitments because, for both the client and
the auditor, the change is disruptive to the audit. 2 When voluntary rotation does occur, the most
frequently cited reasons given were retirements, relocations, medical emergencies, and new
public-client responsibilities. Consistent with this reasoning, we find that the incidence of
rotation in our sample is 16.4 percent, which is close to the expected 20 percent if partner
rotations were to occur precisely every five years under the mandatory rotation provisions
specified in SOX. However, as we are unable to determine whether comment letters are issued
evenly throughout the audit partners tenure, 20 percent may not be the correct expected
mandatory rotation rate. Hence, despite the fact that rotations in our sample appear to be largely
mandatory, because we cannot conclusively determine whether this is the case, we cannot rule
out the possibility that some rotations occurred voluntarily as damage control measures.
2
These discussions are relevant for our study given that 91.2 percent of our sample has a Big 4 auditor.
5
Fourth, we identify partner rotations when new audit partners are copied in comment
letter correspondence. If a firm also copies a prior partner, then we record a non-rotation, even
though a rotation could have taken place, leading to possible measurement error in our non-
rotation sample. This measurement error may be a reason why our observed partner rotation
rate is 16.4 percent instead of 20 percent under mandatory rotations, and will bias against our
results. We perform additional analyses to ensure our results hold in a clean subsample of non-
rotations.
improving financial reporting quality, increases in write-downs, negative special items, and
reporting does not necessarily better reflect the underlying business performance. For example,
firms can write down their assets or increase valuation allowances to better reflect economic
circumstances, or they may take such actions in order to be able to report better results in the
future. However, in our sample the increases in valuation allowances and decreases in positive
special items appear to be driven by the auditor and not the firm, suggesting that such changes
are consistent with DeAngelos (1981) conceptual definition of audit quality. Moreover, recent
research by Lennox, Wu, and Zhang (2015, Table 6) indicates that year-end audit adjustments
of Chinese audit firms result in significant reductions in pre-audit accruals, which is consistent
with our findings that auditors require more conservative financial reporting. Sixth, while our
use of comment letters permits us to determine lead audit partner rotations, the same cannot be
said for concurring audit partner rotations. Hence, a further limitation of our study is an
uncertainty as to whether our findings reflect the effects of lead partner rotations or the joint
Our contribution to the existing literature is to provide some evidence suggesting that
partner rotation permits a fresh look at U.S. audit engagements. Our study closely relates to that
6
of Lennox et al. (2014), who examine mandatory partner rotation in China, using proprietary
audit adjustment data to measure audit quality. Lennox et al. (2014) show that audit
adjustments increase in the year after mandatory partner rotation. 3 Our paper extends their
work to the U.S. setting, using publicly available data for both partner identification and audit
quality measures.
We believe that our study will inform the U.S. debate over audit firm rotation by
providing some evidence suggesting that (1) firm rotation is not the only means available to
provide fresh looks at audit engagements, and (2) the current fresh look mechanism has a
measurable effect. Our findings also support the PCAOBs recent rules requiring the disclosure
of audit partner names starting in 2017 (PCAOB 2015a). Disclosing partner identities would
allow financial statement users to identify partner rotation schedules and, in turn, anticipate
Background
In the U.S., audit partner rotation is the primary quality assurance practice to encourage
independence in the U.S., SOX decreased the period of mandatory partner rotation from seven
to five years (SOX, Section 203) and encouraged studies examining the impact of mandatory
audit firm rotation (SOX, Section 207). More recently, to improve the transparency and the
accountability of the audit process, the PCAOB will require audit engagement partners to
disclose their identities (PCAOB 2015a) and proposed that auditors provide 28 quality
3
Lennox et al. (2014) also find evidence of an increase in audit adjustments in the year prior to mandatory
rotation, suggesting that audit partners increase audit scrutiny when they expect their work to be reviewed by an
incoming partner.
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Given the importance of partner rotation for supporting the independence of U.S.
auditors, the purpose of this study is to examine the empirical evidence of the rotation
mechanism's effectiveness. Although prior research identifies benefits of partner rotation (e.g.,
Bamber and Iyer 2007), noted drawbacks include the ability of management or the audit
committee to influence the selection of the new audit partner (e.g., Cohen et al. 2010; Beasley,
Carcello, Hermanson, and Neal 2009) as well as a decrease in partner expertise, because
incoming partners are less likely to have specific industry experience (e.g., Daugherty et al.
2012). Research also proposes that new partners spend less time on audit quality related
There are only a few studies that examine the audit quality effects of partner rotations
for U.S. public companies. Manry, Mock, and Turner (2008) investigate audit partner tenure
and discretionary accruals using hand-collected audit records from a sample of 90 firms,
finding that discretionary accruals decline with partner tenure for small firms, but not for large
firms. Litt, Sharma, Simpson, and Tanyi (2014) use the fifth consecutive year after an audit
firm change to proxy for an audit partner change and find lower earnings quality following a
presumed partner rotation. Specifically, they observe increases in the propensity to meet or beat
earnings forecasts using discretionary accruals, and decreases in the propensity to issue going-
An issue with both Litt et al. (2014) and Manry et al. (2008) is the use of accruals as the
measures of audit quality, which Bamber and Bamber (2009) find to be an unsatisfying proxy
for audit quality. One study that addresses this concern in the U.S. not-for-profit setting is
Fitzgerald, Omer, and Thompson (2015), who note an increase in the likelihood of reporting an
internal control deficiency during the second year after a partner rotation. While not looking at
audit quality per se, Bedard and Johnstone (2010) utilize a proprietary sample from a single
U.S. audit firm, and find that audit partners invest a significant amount of additional time
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following partner rotation. Lennox et al. (2014) also move away from the use of accruals and
examine the effects of mandatory partner rotation using a proprietary database of audit
adjustments. They observe that audit quality increases in the years prior to and following
The majority of empirical partner rotation studies use data from the following countries
where the identification of audit partners is required: Australia (e.g., Carey and Simnett 2006;
Fargher, Lee, and Mande 2008; Azizkhani et al. 2012), Taiwan (e.g., Chi and Huang 2005;
Chen et al. 2008; Chi et al. 2009), Germany (e.g., Gold et al. 2012), and China (e.g., Firth et al.
2012; Lennox et al. 2014). 4 These studies examine rotations, which range from the purely
voluntary (e.g., Carey and Simnett 2006; Chen et al. 2008) to those identified as mandatory
(Chi et al. 2009; Lennox et al. 2014). While these studies provide valuable insights into the role
of partner rotation, the applicability of such findings to the U.S. depends upon the extent that
the incentives of companies and auditors as well as institutional and political features in the
Overall, the international studies we cited provide conflicting results. For example, Chi
and Huang (2005) consider the association between audit firm and audit partner tenure in
Taiwan using discretionary accruals. They find that earnings quality appears to improve for
approximately five years, but then declines with further increases in tenure. However, Carey
and Simnett (2006) find that longer audit partner tenure is negatively associated with financial
reporting quality in a study of partner rotation, which utilizes cross-sectional Australian audit
partner tenure data from a single-year, 1995. Chen et al. (2008) find contradictory results in
4
Audit partner identification allows researchers and investors to observe changes in audit partners but the audit
partner signature can also induce reputational incentive effects on audit partner behavior, potentially confounding
inferences about partner rotation (e.g., Bamber and Iyer 2007). For example, Carcello and Li (2013) find evidence
of improved audit quality through a decline in earnings management after the introduction of engagement partner
identification in the United Kingdom.
5
For example, the institutional and political features of China are substantially different from those of the U.S.
Lennox, Wu, and Zhang (2015) note that in China, the government has significant influence over the economy and
there are weak legal protections for investors.
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Taiwan, where longer tenure is associated with lower discretionary accruals. Interestingly, in
the same study, Chen et al. (2008) also note that over half of partner rotations result in the
partner rotating back to the client after a single year time-out period. Chi et al. (2009) consider
the first year of mandatory partner rotation in Taiwan (i.e., 2004) and find only weak evidence
of lower quality financial reporting. Azizkhani et al. (2012) study the relation between audit
partner tenure, rotation, and the cost of capital, finding that partner rotation is associated with a
higher cost of capital. Lastly, Lennox et al. (2014), using a proprietary sample of audit
adjustments in China, find evidence that mandatory rotation is associated with higher audit
quality in the years before and after mandatory rotation. They also observe that voluntary
rotation is less likely when clients have financial reporting problems. Hence, approximately
half of the aforementioned studies find that partner rotation increases audit quality, and the
Hypotheses
Audit quality has been defined as the auditors ability to (1) discover errors or breaches
in the accounting system, and (2) withstand client pressures to disclose selectively in the event
a breach is discovered (DeAngelo 1981, p. 115). Partner rotation may affect audit quality as a
partner rotation may result in the loss of significant industry- and firm-specific knowledge,
favoring the argument for longer partner tenure. On the other hand, there are benefits to
rotation: a long-tenured partner may become complacent and provide less thorough audits,
because repeated interactions with management can lead to less critical reviews. Furthermore, a
new partner may bring a fresh look to the engagement, along with new knowledge and
techniques. With respect to independence, it is assumed that an incoming partner will have a
more distant relationship with client personnel and may be more willing to challenge
management estimates and assertions. However, a possible disadvantage in this case is that a
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new partner's limited industry- and firm-specific knowledge may lead to reticence in exercising
independence and challenging management estimates, especially during the early years of their
involvement. Given these conflicting factors, if the partner rotation provides additional
independence and the fresh look that the policy is designed to achieve, then audit quality on
We agree with the suggestion of Bamber and Bamber (2009) that empirical tests must
be well-specified in order to provide valid inferences because the effects of audit rotation may
be modest. Our aim in this study is to apply DeAngelos (1981) concept of audit quality, and to
accomplish this we move beyond the use of discretionary accruals and earnings response
coefficients through an examination of changes in financial reporting measures that new audit
partners are likely to influence. First, we examine the incidence of restatements (e.g., Palmrose,
Richardson, and Scholz 2004; Hribar and Jenkins 2004; Kinney, Palmrose, and Scholz 2004,
Liu, Raghunandan, and Rama 2009). Hennes et al. (2014) find that audit firms are more likely
revealing a restatement, then the outgoing partner has incentives to delay the detection and
announcement of a restatement. If the new audit partner identifies and corrects GAAP errors
and inconsistences, and is able to attribute the restatement to the prior audit partners tenure,
then the incidence of restatement discoveries and announcements should increase following the
partner rotation, providing possible insights into the effect of the fresh look. Moreover, if the
incoming partner provides a more thorough audit than the previous partner and improves the
financial reporting processes of the client, then the frequency of misstatements may decrease
Second, we examine the incidence of write-downs and special items surrounding the
partner rotation. Managers can exercise discretion to delay write-downs (e.g., Ramanna and
Watts 2012, Lawrence, Sloan, and Sun 2013) and record special items (e.g., McVay 2006).
11
Hence, an important function of the auditor is to assess whether the firms assets are impaired,
or if charges need to be accrued. In turn, examining the frequency of write-downs and special
items following auditor rotations may also indicate circumstances where the new audit partner
identifies and requires corrections of GAAP errors and inconsistences that were overlooked by
the prior partner. Third, we examine the changes in allowances following partner rotation.
Disclosure of balances of and changes in allowances are required in the 10-K, either in a
Schedule II or in the notes to the financial statements. One example of a valuation allowance
and reserve account is the allowance for doubtful accounts. For this allowance, management
estimates are used to determine the opening and closing balances, the bad debt expense during
the period (increasing the allowance), and write-offs for uncollectible debts (reducing the
allowance). Cassell, Myers, and Seidel (2015) argue that companies will use allowances to
manage earnings if the probability of detection is sufficiently low. Given the significant amount
of discretion inherent in determining allowances, and the important effect that these accounts
have on the financial statements, auditors spend considerable effort assessing their
reasonableness and accuracy. Therefore, if partner rotations do, in fact, provide a fresh look at
the audit engagement, we expect to see increases, or fewer decreases, in allowances, following
Endogenous partner rotations are a concern in our setting because we cannot observe
whether a partner rotation is mandatory or voluntary. Partner rotation may cause the observed
financial reporting measure to change, or, on the other hand, the audit partner may be rotated
out as a result of changes in these measures. For example, if a restatement prompts the partner
rotation, then the restatement would have occurred prior to rotation. In this case, post-rotation
restatements will be exogenous. We review each restatement, and verify that none are
prompted by SEC comment letter reviews (i.e., Cheng, Gao, Lawrence, and Smith 2014).
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Because management has overall responsibility for the preparation of financial
statements and the departing audit partner still has a professional duty to fulfill, the anticipated
partner rotation is unlikely to cause the pre-rotation financials to be misstated. If anything, the
departing partner may conduct a more thorough audit during the year prior to rotation if she has
concerns that the incoming partner will review her work and report sub-standard behavior
within her firm (Lennox et al. 2014). Consequently, we could observe either no changes to the
allowances), or a combination of changes in these measures prior to partner rotation and after
partner rotation.
Lennox et al. (2014), in their examination of the actual audit adjustments of Chinese
auditors surrounding mandatory partner rotations, provide evidence suggesting that audit
quality increases in the year immediately preceding and following the mandatory partner
rotation. Consistent with the foregoing inferences from Lennox et al. (2014), if the proposed
benefits of partner rotation exceed the costs, the new partner may find errors or inconsistencies
with the financial reporting practices of the client and require the client to disclose such errors
should see increases in restatement discoveries and announcements, write-downs and special
items, and allowances, and decreases in misstatements. Hence, our three hypotheses are as
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3. RESEARCH DESIGN AND DATA
Research Design
We identify audit partner rotations utilizing SEC comment letter correspondences for
issuers who have received comment letter reviews in two consecutive years that copy different
audit partners for each of those years. To ensure that the results of the study do not simply
reflect the effects of the two consecutive comment letter reviews, we implement a difference-
in-differences strategy, matching partner rotation firms to control firms that have comment
letter reviews in consecutive years, but copy the same audit partner. We match treatment and
control firms by year, Fama-French 49 industry codes, and market value (closest).
conditional logit specifications, where the matched pair groupings serve as the conditioning
variable (see Cram, Karan, and Stuart 2009). We estimate the following restatements models:
where I(Restatement discoveryi,t) equals 1 for firm i in year t, if the firm discovers a
restatement after the annual report is filed for year t-1 and on or before the date the annual
report is filed for year t, and 0 otherwise, as depicted in Figure 1. We read each restatement
discussion during our sample period to determine when the issue was discovered by the
company. If the discovery date is not disclosed, we assume that the announcement date is also
the discovery date. If the company only reports the financial reporting period that restatement
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was discovered and not a specific date, we assume the discovery was made on the first day of
the period. I(Restatement announcementi,t) equals 1 for firm i in year t, if the firm announces
a restatement after the annual report is filed for year t-1 and on or before the date the annual
report is filed for year t, and 0 otherwise, again as depicted in Figure 1. The announcement
date is available from Audit Analytics. I(Misstatementi,t) equals 1 if a firm i restates any
portion of fiscal year t, and 0 otherwise. The misstatement period is also available from Audit
Analytics. POSTi,t equals 1 if the year corresponds to the first or second year following the
partner rotation (Year 0 or Year 1), but 0 if the year corresponds to the first or second year
prior to the partner rotation (Year -1 or Year -2); and TREATi,t equals 1 if the firm is a partner
rotation firm, but 0 if the firm is a control firm. We include the following set of control
variables, which Dechow, Ge, Larson, and Sloan (2011) show predict restatements: Total
securities issuance (I(Issuance)), Return on assets, Return on assets, an indicator for having a
Big 4 auditor (I(Big 4 auditor)), Age, Book to market, and the natural logarithm of Market
value. Detailed variable definitions are presented in Appendix A. We also include fixed effects
for the SEC office issuing the comment letter. For the restatement discovery and announcement
regressions, a positive and significant coefficient for 3 is consistent with H1, that partner
statement restatements, which suggests that new audit partners catch errors in prior financial
statements that were not caught by the previous audit partner. For the misstatement regressions,
a negative and significant coefficient for 3 is consistent with H1, that the incoming partner
To examine the effect of audit partner rotations on the incidence of write-downs and
special items, we estimate the following models using logit and conditional logit specifications:
15
I(Write-downi,t) = 0 + 1 TREATi,t + 2 POSTi,t + 3 TREATi,t * POSTi,t + (4)
CONTROLS + i,t ,
CONTROLS + i,t ,
CONTROLS + i,t ,
I(Negative special itemi,t) equals 1 if firm i has a negative special item (expense) in year t, but
0 otherwise; and I(Positive special itemi,t) equals 1 if firm i has a positive special item
(income) in year t, but 0 otherwise. Because write-downs and special items are relatively
infrequent events, yet they may have extreme values, we estimate these models using indicator
variables for the dependent variables to prevent outliers from influencing the results. POSTi,t
and TREATi,t are defined as for Equation (1). We control the following documented
determinants of write-downs and special items: the level of Intangibles, an indicator if Book to
market is greater than one (I(Book to market > 1)), Operating income, and the natural logarithm
of Market value (e.g., Lawrence et al. 2013). Consistent with H2, we expect 3 to be: positive
for Equation (4), if partner rotation is associated with an increase in write-downs of impaired
assets; positive for Equation (5), if partner rotation is associated with an increase in negative
special items; and negative for Equation (6), if partner rotation is associated with a reduction in
16
where Dependent variablei,t refers to one of the following values for firm i in year t: Total
allowance, Allowance for doubtful accounts, Inventory allowance, Deferred tax asset
allowance, Sales returns allowance, Loan loss allowance, and Other allowance. More
specifically, Total allowance is the sum of all allowance accounts for each firm-year;
Allowance for doubtful accounts is the estimate of uncollectible accounts receivable; Inventory
estimate of future tax benefits that will not be realized; Sales returns allowance is an estimate
of current period sales that will be refunded; Loan loss allowance is an estimate of loans that
will not be repaid; and Other allowance is the sum of all valuation allowances or reserve
accounts that did not fit into one of the above sub-categories. Examples of other allowances and
reserve accounts include estimated future product warranty costs, estimated asset impairment
reserves, estimated future workers compensation costs, and many others. Allowance variables
are scaled by the sum of the ending balances of all allowances and total assets. POSTi,t and
TREATi,t are defined above in Equation (1). We control for the following factors that are likely
to influence changes in these allowance accounts but are unrelated to the audit rotation: Time in
receivables, Time in inventory, Return on assets, an indicator for a loss (I(Loss)), Book to
market, the natural logarithm of Sales, the natural logarithm of Cost of goods sold, and the
with H3's conjecture that audit partner rotation is associated with an increase in allowances.
Data
We utilize the Audit Analytics Comment Letter database to identify SEC comment
letter correspondences spanning the decade from 2004 to 2014. Employing audit fee data from
Audit Analytics, we identify 49 audit firms with market share ranked in the top ten from 2000
to 2014. We then search the Audit Analytics Comment Letter Database field
17
those copied on the correspondence. Searching for partner names associated with the 49 audit
firms, we identify 1,940 client firms that copy their audit partner by name in correspondence
The date of the comment letter response is taken as the service date for the partner
copied, following which we utilize the Compustat annual file to assign fiscal years to service
dates. For every firm-year with at least one service date, we create a list of all names copied in
comment letter responses during that year. We assume these are the individuals serving the
company for that fiscal year (providing, for example, quarterly reviews, internal control
evaluations, and year-end audits). Conversations with auditors confirm that clients tend to cc
the current audit partner who will be responsible for the subsequent 10-K audit opinion.
In some cases there are multiple names from the same audit firm copied in one letter. In
untabulated analysis, we find that 56 percent of comment letters in our sample contain more
than one name. In order to determine a partner rotation, we require that for any given client the
list of auditor names in the pre-rotation year does not share any names with the post-rotation
year, and that all names belong to the same accounting firm. Year 0 is defined as the year in
which a new partners name is observed in a firm's correspondence with the SEC. We identify
142 partner rotations in which the outgoing partner was named in Year -1 and 136 partner
rotations in which there is no comment letter in Year -1 and the outgoing partner is named in
Year -2. For the latter type of partner rotation, we assume the departing partners final year is
Year -1 and the new partners first year is Year 0. 6 To mitigate the effect of possible voluntary
rotations, we check that there are no other rotations observed within each four-year period.
Partner non-rotations are defined as firms for which the same partner name appears in the pre-
6
When we assume the departing partners final year is Year -2 and the new partner first year is Year -1, the
studys main inferences are generally similar, albeit stronger for the restatement analyses, insignificant for the
write-down and special-items analyses, and weaker for the allowance analyses. For the allowance analyses, we
find that results in Table 6, Panel A become insignificant (p > 0.10) but remain significant (p < 0.05) in Panels B
and C.
18
and post-period. Appendix B provides an example of how we use the comment letter
correspondence to identify audit partner rotations, and Figure 1 illustrates the specific timing of
this process. In our final sample, we manually check a subsample of 50 identified names, using
Google and LinkedIn to confirm that the named individuals are indeed audit partners.
We include two years of data before the partner rotation and two years after the partner
rotation, where available, for each partner rotation event. We match each partner rotation firm
to a non-rotation control firm in Year 0, which must be the same fiscal year for both the partner
rotation firm and the control firm. We observe non-rotations when the same audit partner is
copied in either Year -2 or Year -1, and in Year 0. 7 We further require that the control firm not
have any other observed rotations in the four-year window from Year -2 to Year 1. A valid
control must be in the same Fama-French 49 industry group as the rotation firm. Both the
rotation firm and the control are required to have all variables available in Years -1 and 0 at a
minimum, and where additional years are available, the rotation and control firm-year
observations must match. For each rotation firm, we select the available control firm closest in
database, which includes Form 8-K, item 4.02 disclosures, as well as other filings that contain
variations of the word restate, including Forms 8-K, 8-K/A, 10-K, 10- Q, 10-Q/A, 10-K/A,
presentation as a result of mergers. We read the disclosure of each restatement in our sample to
7
In 30 percent non-rotation observations, there are multiple names copied on the comment letters with one name
that stays the same, but also one name that changes from the pre-period to the post-period. For example, Kate and
John may be copied in the pre-period and Kate and Jill are copied in the post-period. This observation may, in fact,
be a rotation event, with John as the outgoing partner and Jill as the incoming audit partner. We perform an
additional analysis and ensure our main results are not sensitive to these observations.
19
determine when the accounting issue was discovered by the company. The restatement
announcement date and the misstatement period are available from Audit Analytics.
We obtain write-down and special item data from the Compustat annual file; see
Appendix A for detailed variable definitions. Also, we hand-collect allowance account activity
from companies financial statements. Our initial source of data for allowance account activity
material valuation allowance and reserve accounts 43 percent of firms in our sample report
this schedule. Firms that do not report this schedule are required to include this information, if
material, in the footnotes to their financial statements. Consequently, we search each annual
report manually using a list of common allowance account terms to identify and collect
activities and balances in these accounts. The majority of the 57 percent of firms that do not
report a Schedule II do report the ending balance of at least one allowance account, although
many do not report the annual activity despite the requirement to do so. As such, the sample
sizes are insufficient for testing activity in allowance accounts, although they are sufficient for
4. RESULTS
Table 1, Panel A provides details about our sample. We begin with 11,710 firms
(75,505 firm-years) in Compustat with required variables available from 2004 to 2014. Because
we use comment letters to identify audit partners and, in turn, partner rotations, our sample is
limited to those firms that have received comment letters from the SEC in consecutive years.
We find that 8,940 firms (76.4 percent of Compustat firms) have received a comment letter at
least once during our sample period and 6,626 firms (56.6 percent) received comment letters
for two of three years. Panel A demonstrates that limiting our sample to firms that copy the
audit partner on comment letter correspondences results in the greatest sample attrition.
20
Specifically, we find that 568 firms (1,240 firm-years) copy the audit partner by name on
comment letter correspondences for two of three years, which means that we can identify
rotations and non-rotations for 4.9 percent of Compustat firms. After the application of these
restrictions, we identify 278 rotations across 241 firms (2.1 percent of Compustat firms) and
962 non-rotations across 507 firms (4.3 percent of Compustat firms). The final restatement,
write-down and special item, and valuation allowance and reserve samples contain 198, 205,
and 192 rotation observations, respectively, when further restricting the samples to those
Table 1, Panel B illustrates that the industry composition of our partner rotation sample
and the Compustat population are similar. Trading, Banking, and Computer Software are the
three most frequent industries in both our sample and in the Compustat population. Our sample
lacks representation from some of the smaller industries. For example, Restaurants, Hotels,
Motels is the largest industry missing from our sample, which represents 1.2 percent of
Compustat firm-years.
Table 2 provides means and medians for all variables in our partner rotation sample, the
matched non-rotation sample, and the 2004 2014 Compustat population. Panel A presents the
primary variables and sample used in the restatements analysis, Panel B presents the primary
variables and sample for the write-downs and special items analysis, and Panel C gives the
primary variables and sample for the allowances analysis. In Panel A, the incidence of
restatement discovery is lower for partner rotation firms than non-rotation firms: specifically,
6.8 percent and 8.0 percent of rotation and non-rotation firm-years, respectively, have
restatements discovered during the year. The incidence of restatement announcement is also
lower for partner rotation firms than non-rotation firms: specifically, 6.8 percent and 8.3
during the year, values comparable to the to the overall Compustat population incidence of 6.6
21
percent. The incidence of a misstatement is fairly similar between partner rotation and non-
rotation firm years, at 14.8 and 12.8 percent, respectively, values comparable to the overall
Compustat population incidence of 13.8 percent. The control variables are similar across the
rotation and non-rotation firms, with the exception of the Leverage ratios, Return-on-assets,
and Market value. The Leverage ratio is lower for partner rotation firm-years, with a mean
(median) value of 0.928 (0.405), compared to 1.338 (0.476) for non-rotation firm-years. Return
on assets is higher for partner rotation firm-years, with a mean (median) value of 0.035 (0.038),
versus 0.004 (0.024) for non-rotation firm-years. Market value is higher for partner rotation
firm-years with a mean (median) value, in millions, of $12,733 ($2,752) versus $6,380 ($1,872)
for non-rotation firm-years. Overall, rotation and non-rotation firms are fairly similar to the
overall Compustat population, although rotation and non-rotation firms are larger and,
consequently, have a higher frequency of Big 4 auditors. This size differential corresponds to
the findings of Cassell, Dreher, and Myers (2013) and Dechow, Lawrence, and Ryans (2016)
that larger firms are more likely to receive comment letters, due to the reporting complexity of
larger firms and as well as the fact that the SEC aims to conduct more frequent examinations of
In Table 2, Panel B the incidence of write-downs and special items is similar for
rotation and non-rotation firms: 26.0 percent and 23.1 percent of firm-years, respectively.
Likewise, the incidence of negative special items is 55.0 percent and 56.5 percent of firm-years
for rotation and non-rotation firms, respectively; and the incidence of positive special items is
8
In untabulated analyses, we find that audit partners are more likely to be copied on comment letters for larger
firms, for firms that have Big 4 auditors, if it is the firms first publicly disclosed SEC comment letter
conversation, and when the comment letter review raises questions about revenue recognition or includes more
rounds. Characteristics such as firm valuation multiples, profitability, growth rates, and leverage do not explain
whether the audit partner is copied.
9
In untabulated analysis, we find that many of the firms in our sample are members of the S&P 500 (e.g., Pfizer,
Bank of America, Cisco Systems, Amazon, etc.). The partner rotation sample includes some large foreign issuers
that would not have been required to rotate partners until 2009 due to SEC rule 33-8183 (SEC 2003). We re-run
our analyses excluding those rotations in foreign firm-years prior to 2009 and find results similar to those
presented in our main analyses.
22
17.3 percent and 18.3 percent of firm-years for rotation and non-rotation firms, respectively.
Both rotation and non-rotation firms have a higher incidence of write-downs, negative special
items, and positive special items than the 19.1 percent, 44.1 percent, and 14.8 percent of firm-
years observed, respectively, for the Compustat population. The incidence of Book to market
greater than one and the fraction of Intangibles to total assets are similar for rotation and non-
rotation firms. The incidence of Book to market greater than one is 16.1 percent and 17.9
percent of firm-years for rotation and non-rotation firms, respectively, and the mean (median)
values of Intangibles to total assets are 0.159 (0.067) and 0.183 (0.051) for rotation and non-
rotation firm-years, respectively. While the incidence of firm-years with Book to market greater
than one for the Compustat population of 16.9 percent is similar to that of rotation and non-
rotation firm-years, the mean (median) value of Intangibles to total assets of 0.128 (0.030) for
the Compustat population is lower than the corresponding values for rotation and non-rotation
firm-years.
In Table 2, Panel C the total amount of allowances is lower for rotation than non-
rotation firms. Specifically, the mean (median) value of Total allowance is 2.434 (0.702)
percent of assets for rotation firm and 3.748 (1.165) percent of assets for non-rotation firms.
Because the valuation allowance and reserve data for our sample were hand collected, we are
unable to report comparable statistics for the Compustat population. Many of the individual
allowances are similar for rotation and non-rotation firms; however, the Inventory allowance
and the Deferred tax asset allowance are lower for rotation than for non-rotation firms. In
particular, the mean (median) Inventory allowance is 0.059 (0) percent of assets for partner
rotation firm-years and 0.161 (0) percent of assets for non-rotation firm-years, values which
correspond to the Time in inventory figures of 0.513 (0.075) and 1.304 (0.082) for partner
rotation and non-rotation firm-years, respectively. The mean (median) Deferred tax asset
allowance is 1.470 (0) percent of assets for partner rotation firm-years and 2.842 (0.006)
23
percent of assets for non-rotation firm-years, which are partially explained by the Return on
assets values of 0.036 (0.035) and 0.014 (0.025) for rotation and non-rotation firm-years,
respectively.
conditioning on partner rotation firms (TREAT = 1) and non-rotation firms (TREAT = 0) during
the pre-rotation (POST = 0) and post-rotation periods (POST = 1). I(Restatement discovery) for
partner rotation firms is 6.77 percent in the pre-rotation period and 6.81 percent in the post-
non-rotation firms decreases from 11.20 percent to 4.63 percent on average over the sample
period. This result is consistent with H1, as the partner rotation firms have relatively more
restatements discovered in the post period than the non-rotation firms. I(Restatement
announcement) for partner rotation firms is 6.25 percent in the pre-rotation period and 7.36
However, I(Restatement announcement) for non-rotation firms decreases from 10.68 percent to
5.72 percent on average over the sample period. This result is also consistent with H1, as the
partner rotation firms have relatively more restatements announced in the post period than the
non-rotation firms. The incidence of misstatements, however, is relatively similar for both
partner rotation firms and non-rotation firms in the pre- and post-rotation periods.
I(Misstatement) is 15.89 percent for both partner rotation and non-rotation firms in the pre-
rotation period, dropping to 13.62 percent for partner rotation firms and 9.54 percent for non-
Inconsistent with H2, I(Write-down) for partner rotation firms decreases from 27.65
percent to 24.35 percent from the pre- to post-rotation periods. The decrease in I(Write-down)
for non-rotation firms is slightly smaller, going from 24.44 percent in the pre-rotation period to
21.73 percent in the post-rotation period. While I(Negative special item) for partner rotation
24
firms increases from 53.33 to 56.81 percent from the pre-rotation period to the post-rotation
periods, in agreement with H2, there is no change in I(Positive special item) for partner rotation
firms. Interestingly, we observe a sharp decrease in I(Negative special item) and a sharp
increase in I(Positive special item) for non-rotation firms, which was not anticipated. One
possible explanation is that the partners of the non-rotation firms, who we presume are in the
first, second, or third year of service to their respective clients, are more likely to require
conservative special item charges in the first half of their terms (i.e., the pre-rotation period).
Finally, consistent with H3, the Total allowance for partner rotation firms increases
from 2.14 percent of total assets in the pre-rotation period to 2.75 percent in the post-rotation
period, while across the same periods the value for non-rotation firms decreases from 3.85 to
3.64 percent. The two allowances that provide the greatest contribution to the Total allowance
are the Deferred tax asset allowance and Other allowance. Across the pre- to post-rotation
periods, the mean Deferred tax asset allowance increases from 1.22 percent of total assets to
1.74 percent for partner rotation firms, while decreasing from 2.98 percent to 2.69 percent for
non-rotation firms. The mean Other allowance increases from 0.12 percent of total assets pre-
rotation to 0.23 percent post-rotation, whereas non-rotation firms see only a slight increase
Restatements Analysis
Figure 2, Panel A, which plots the yearly restatement discovery rates for partner
rotation firms and non-rotation firms during the pre-rotation years (Years -2 and -1) and post-
rotation years (Years 0 and 1), confirms the inferences from Table 3 that, relative to non-
rotation firms, I(Restatement discovery) for partner rotation firms does not decline as much as it
does for non-rotation firms, indicating a relative increase in restatement discoveries post-
rotation. Hence, the significant increases in I(Restatement discovery) for partner rotation firms
relative to non-rotation firms following the rotation suggest that the new audit partner is
25
associated with a higher level of restatement discoveries. Panel B, which plots the yearly
restatement announcement rates for partner rotation firms and non-rotation firms during the
pre-rotation years (Years -2 and -1) and post-rotation years (Years 0 and 1), confirms the
inferences from Table 3 that I(Restatement announcement) for partner rotation firms increases
subsequent to partner rotation, while at the same time as the incidence of restatement
announcements decreases for non-rotation firms. The decrease in restatement discoveries and
announcements for the non-rotation firms reflects the decreasing trend in restatement
discoveries and announcements for the Compustat population over our sample period.
Moreover, the reduction in the restatement discovery and announcement frequencies for the
non-rotation firms is also likely due to the fact that these firms will on average have just
experienced a partner rotation in the pre-period and hence, have higher restatement discovery
and announcement frequencies in the pre-period relative to the post-period due to the partner
rotation. Finally, in Panel C, I(Misstatement) declines for both groups of firms, though the
decline is not as pronounced for the partner rotation firms. Hence, while there is a relatively
similar trend in misstated periods for the two groups of firms, there are relatively higher levels
of restatement discovery and announcement for the partner rotation firms, suggesting that the
new audit partner is associated with a higher level of restatement discoveries and disclosures.
dependent variables, we use a traditional logit specification and a conditional logit specification
that conditions on each matched pair of a partner rotation observation and its corresponding
matched non-rotation observation. Using Equation (1), we regress the indicator variable
I(Restatement discovery) on the indicators TREAT and POST, as well as TREAT*POST, which
effects for each SEC office that issues comment letters. Following Equation (2) we perform a
26
similar regression for I(Restatement announcement), and following Equation (3), for
I(Misstatement).
significant in the logit specification (coeff. = 0.985; p < 0.05) and slightly weaker in the
conditional logit specification (coeff. 0.862; p < 0.10). The conditional logit result corresponds
specification (coeff. = 0.879; p < 0.05) and again slightly weaker in the conditional logit
specification (coeff. 0.741; p < 0.10). The conditional logit result corresponds to a relative
coefficient on TREAT*POST is positive but not significant in the logit or conditional logit
specifications. The control variables Return on assets and Market value are the most significant
for the restatement discovery and announcement dependent variables. For restatement
discovery and announcement, the coefficient on Total accruals is inconsistent with the
prediction of Dechow et al. (2011). It is important to note, however, that our primary outcome
variables are the discovery and announcement of a restatement, and hence, our explanatory
control variables are lagged by one year to reflect the likelihood that the period being restated is
the prior year. Where misstatement is the dependent variable, the coefficient on Total accurals
is significant and in the predicted direction (coeff. = 1.394; p < 0.01). Overall, Table 4 provides
support for H1 that partner rotations are associated with increases in restatement
We examine the differences in the types of restatements made by partner rotation and
non-rotation firms. In untabulated analysis we find that the restatement discoveries and
10
The relative increase is computed as the change in the expected value of the I(Restatement discovery) log odds
ratio, setting POST = 1 and varying TREAT between 0 and 1, then converting the change in odds to a change in
probability that I(Restatement discovery) = 1.
27
announcements for partner change firms are generally similar to those of non-rotation firms,
and primarily relate to related party or subsidiary issues, accounting for income taxes, cash
I(Negative special item), and I(Positive special item), respectively. Results are consistent with
the inferences in Table 3. The effects of new partner rotation on I(Write-down) appear
insignificant. The difference in I(Negative special item) between partner rotation and non-
rotation firms increases from Year -1 to Year 0, with marginal significance. Specifically,
I(Negative special item) for partner rotation firms increases from 52.0 percent and 54.6 percent
in Years -2 and -1 to 55.1 percent and 58.8 percent in Years 0 and 1, respectively. However,
I(Negative special item) for non-rotation firms actually decreases from the pre- to the post-
rotation period, declining from 55.5 percent and 61.0 percent in Years -2 and -1, respectively,
to 52.7 percent and 57.1 percent in Years 0 and 1, respectively. The difference in I(Positive
special item) between partner rotation and non-rotation firms clearly decreases in Year -1 to
Year 0. While I(Positive special item) for partner rotation firms is fairly flat in the pre- and
post-rotation periods averaging out at 17.3 percent in both periods, I(Positive special item) for
non-rotation firms substantially increases from 14.5 percent and 12.7 percent in Years -2 and -1
to 23.4 percent and 23.2 percent in Years 0 and 1, respectively. Therefore, the foregoing plots
suggest that, relative to non-rotation firms, I(Negative special item) increases and I(Postive
downs and special items using Equations (4), (5), and (6), where the indicators I(Write-down),
I(Negative special item), and I(Positive special item), are regressed on TREAT, POST,
TREAT*POST. For each equation, the first column presents the traditional logit specification
28
and the second column presents the conditional logit specification. For the dependent variable
logit and conditional logit specifications, indicating that in our sample partner rotation does not
have a statistically significant effect on the incidence of write-downs. For the dependent
variable I(Negative special item), the coefficient on TREAT*POST is positive, but not
significant at conventional levels in both logit and conditional logit specifications. For the
dependent variable I(Positive special item), the coefficient on TREAT*POST is negative and
significant in the logit specification (coeff. = -0.672; p < 0.05) and in the conditional logit
specification (coeff. = -0.692; p < 0.05), which suggests a relative decrease in positive special
items for rotation firms following partner rotation of 8.6 percentage points. The control
variables, Intangibles, I(Book to market > 1), Operating income, and log (Market value), are all
significant for explaining I(Write-down) and their signs are consistent with the prior literature;
however, they are less consistent in explaining I(Negative special item) and I(Positive special
item). In an additional analysis discussed at the end of the paper, we run the same tests in a
clean subsample in which the identification non-rotation control firms are unambiguous. Within
this subsample, the positive special item results are no longer significant. Consequently, we put
Allowances Analysis
rotations. Panel G shows a clear increase in the Total allowance, the sum of all allowance
accounts, from the pre-rotation to the post-rotation period. Specifically, the Total allowance for
partner rotation firms increases from 1.93 percent and 2.35 percent of total assets in Years -2
and -1, respectively, to 2.54 percent and 3.00 percent of total assets in Years 0 and 1, while the
Total allowance for non-rotation firms generally decreases from 4.02 percent and 3.68 percent
of total assets in Years -2 and -1, respectively, to 3.48 percent and 3.81 percent of total assets in
29
Years 0 and 1, respectively. Because the Deferred tax asset allowance is significantly larger
than the other allowances, it is the primary driver of the changes in Total allowance. A quick
examination of all allowances in Figure 2 shows that that Deferred tax asset allowance panel
Table 6, Panel A presents the OLS regression results for the difference-in-differences
analysis of allowances using Equation (7), where the allowances (as a percentage of adjusted
total assets) are regressed on TREAT, POST, and TREAT*POST. We include controls for
financial statement variables likely to influence the allowance and reserve balances as well as
fixed effects for each matched pair. In the first results column, the dependent variable is Total
allowance and the coefficient on TREAT*POST is positive and significant (coeff. = 0.809; p <
0.10), indicating that partner rotations are associated with an increase in Total allowance of 0.8
percent of assets following partner rotations. The remaining columns provide similar analyses
for the individual allowances; and consistent with Figure 2, we observe that the largest
contribution (86 percent) to the increase in allowances is from Deferred tax asset allowance
(TREAT*POST coeff. = 0.769; p < 0.10). 11 The Other allowance column shows a positive
coefficient (TREAT*POST coeff. = 0.092; p > 0.10), but is statistically insignificant, and the
TREAT*POST coefficients for the remaining allowances are also are insignificant (e.g.,
Allowance for doubtful accounts, Sales returns allowance, Inventory allowance, and Loan loss
allowance). Several of the control variables are significant and appear to consistently explain
11
The percentage is calculated by comparing the coefficient on Deferred tax asset allowance to all the positive
allowance coefficients: 0.769 / (0.018 + 0.769 + 0.019 + 0.092).
12
In a untabulated analyses, we include a control variable for expected future profitability using next years
forecasted ROA (Consensus Year Ahead EPS * Shares Outstanding / Total Assets, from FactSet) or ROAt+1 for
those firms without analyst coverage, as the deferred tax asset valuation allowance is related to expected future
earnings. We find that our inferences are unchanged.
30
In Panels B and C, we provide some additional analyses regarding the Deferred tax
asset allowance, to confirm that the result is not due to a small number of outliers. Panel B
provides statistics on the percentage of firms with deferred tax assets that experience increases
and decreases in the Deferred tax asset allowance from the pre-rotation period to the post-
rotation period and Panel C provides a regression analysis predicting whether a firm increases
its Deferred tax asset allowance as a function of TREAT plus the control variables used in
Panel A but measured in Year 0 (i.e., the partner rotation year). Panel B indicates partner
rotation firms are more likely to record increases in the Deferred tax asset allowance account,
post-rotation, at 60.9 percent, compared to non-rotation firms at 46.7 percent (p < 0.05). The
regression analysis in Panel C confirms this inference as the coefficient on TREAT is positive
and significant (TREAT coeff. = 0.721; p < 0.05). Taken together, these findings provide some
support for H3, that new audit partners have influence on the clients total allowances, and in
Additional Analyses
We perform additional analyses to corroborate our findings. First, in the main analyses,
we define a non-rotation as consecutive comment letters that have at least one copied audit
partner name in common. However, in 30 percent of these cases there is another name copied
which changes from the pre-period to the post-period, a potential source of measurement error
because the name that changed could, in fact, reflect a partner rotation. Hence, we repeat our
main analyses using a clean subsample, in which all names are the same in the pre-period and
the post-period for the non-rotation firms. The incidence of partner rotation in this subsample is
19.9 percent, nearly equal to the 20 percent expected if partner rotations occur every five years
and consecutive comment letters are evenly distributed across partners tenures.
13
Similar to the Allowance for doubtful accounts results, in unreported analysis, we find insignificant changes in
the bad debt expense following rotation.
31
Table 7 presents all main results for this subsample, and consistent with measurement
error, we find that our results are generally stronger. Panels A, B, and C report the key
in Tables 4, 5 and 6, respectively. Panel A shows that the relative increase in restatement
discoveries have larger coefficients and greater statistical significance compared to the full
sample (e.g., coeff. = 1.376, p < 0.01 compared to coeff. = 0.985, p < 0.05 for the main analysis
in Table 4). Panel B shows that the significant decrease in positive special items is still
negative, but insignificant in the clean subsample (e.g., coeff. = -0.400, p > 0.10 compared to
coeff. = -0.672, p < 0.05 for the main analysis in Table 5). Panel C shows that the increase in
total allowances (coeff. = 1.142, p < 0.05 compared to coeff. = 0.809, p < 0.10 for the main
analysis in Table 6 Panel A) and the deferred tax asset allowance (coeff. = 1.233, p < 0.05
compared to coeff. = 0.769, p < 0.10 for the main analysis in Table 6 Panel A) also have larger
coefficients and greater statistical significance in the clean subsample. Panels D and E illustrate
that the higher likelihood of increasing the deferred tax asset allowance in the clean subsample
identify material restatements. To ensure our findings do indeed only include material
restatements, we repeat our restatement announcement analyses using only 8-K non-reliance
restatement announcements. Specifically, filing 8-K item 4.02 is required if, previously issued
financial statements should not be relied upon because of an error in the statements, or if, the
auditor believes that previously issued audit reports or interim reviews on financial statements
should not be relied upon (SEC 2012). These restatements only include those that are material
using EDGAR filings data by extracting item numbers from all 8-Ks filed during our sample
32
period, and all restatement announcement results are robust although slightly weaker (p < 0.10)
Third, to further rule out concerns that our findings reflect a damage control measure in
investigate the comment letter subject categories and the 3-day cumulative abnormal returns
(CARs) surrounding the comment letter disclosure for both the partner rotation firms and the
non-rotation control firms. The frequency of receiving comment letters for the following topics,
as coded by Audit Analytics, is not statistically different for partner rotation and non-rotation
firms: Accounting Standards; Operational, Controls, and Risk Assessments; Non-Standard and
Other Disclosures; Securities Regulations; New and Secondary Registrations; Mergers and
Acquisitions. Furthermore, if the comment letters for rotation firms address more serious issues
removal of an audit partner, then the market response to rotation firm comment letters should
be more severe than those for non-rotation control firms (Ryans 2015). We find no differences
in the 3-day CARs surrounding the comment letter disclosures between rotation firms and non-
rotation firms, further supporting the notion that our findings reflect the effects of partner
Fourth, we scale each valuation allowance and reserve by the related balance sheet
account instead of total assets. For example, scaling Allowance for doubtful accounts by the
total receivables balance, rather than total assets. All main inferences are similar except that the
Deferred tax asset allowance inference is slightly weaker. Fourth, we find that all our main
inferences hold when we exclude partner rotations involving office changes, ruling out
concerns that our findings reflect the effect of moving to a specialist office.
33
5. CONCLUSION
Audit partner rotation has been a key component of U.S. audit practice for over three
decades and is often regarded as a compromise to implementation of the complete fresh look
that would be obtained through audit firm rotation. Despite the fact that partner rotation is the
main requirement in the U.S. for the provision of fresh looks at audit engagements, limited U.S.
evidence exists on the benefits of partner rotation, because audit partner names are not
disclosed in U.S audit reports. Such evidence is especially important as the requirement for full
U.S. audit firm rotation is periodically proposed by regulators, and it is necessary to understand
Contrary to the findings of prior research, this study provides some initial U.S. public-
company evidence suggesting that auditor partner rotation provides a fresh look at the audit
engagement. Specifically, using SEC comment letter correspondences to identify U.S. audit
partner rotations between 2006 and 2014, relative to non-rotation firms, we find increases in
restatement discoveries and announcements, and deferred tax valuation allowances following
partner rotations. While these findings suggest the fresh look effects are fairly modest, they still
provide some support for the notion that incoming audit partners in the U.S. often require
changes to the financial statements that were not required by the previous engagement partners.
Our studys evidence is also relevant to PCAOBs recent rule requiring the disclosure of
partner names starting in 2017. Opponents of the proposal (e.g., CAQ 2014) suggest that the
disclosure of audit partner names would not provide meaningful or relevant information to
investors. However, as the disclosure of audit partner names would reveal the partner rotation
schedules, our findings indicate that the disclosure of partner names should provide some
useful and relevant information. In particular, such disclosure will enable financial statement
users to anticipate and appreciate potential financial reporting effects of the partner rotations.
34
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37
APPENDIX A
Variable Definitions
Adjusted assetsi,t Sum of all hand-collected ending allowance account balances for firm i in year t
plus ATi,t;
Agei,t Number of years since the first year of Compustat coverage for firm i as of year
t;
Allowance for doubtful Hand-collected ending allowance for doubtful accounts for firm i in year t,
accountsi,t multiplied by 100, scaled by Adjusted assetsi,t
Book to marketi,t-1 Firm i's total assets at the end of year t-1 scaled by the sum of market
capitalization plus total assets minus the book value of total common equity as of
year-end t-1 (ATi,t-1 / (CSHOi,t-1*PRCC_Fi,t-1 + ATi,t-1 - CEQi,t-1));
Cost of goods soldi,t Firm is unscaled cost of goods sold in year t (COGSi,t);
Deferred tax asset Hand-collected ending deferred tax asset valuation allowance for firm i in year t,
allowancei,t multiplied by 100, scaled by Adjusted assetsi,t;
I(Big 4 auditori,t-1) 1 if firm i is audited by Deloitte & Touche, Ernst & Young, KPMG, or
PricewaterhouseCoopers in year t-1, 0 otherwise;
I(Book to marketi,t-1 > 1) 1 if Book to marketi,t-1 > 1, 0 otherwise;
I(Increase DTAi) 1 when the mean Deferred tax asset allowance increases from the pre-period
(POST = 0) to the post-period (POST = 1), and 0 otherwise, such that there is
one observation per four-year period;
I(Issuancei,t-1) 1 if either DLTISi,t-1 > 0 or SSTKi,t-1 > 0, 0 otherwise;
I(Lossi,t) 1 if IBi,t < 0, 0 otherwise;
I(Misstatementi,t) 1 if firm i restates any portion of fiscal year t, 0 otherwise;
I(Negative special itemi,t) 1 if SPIi,t < 0, 0 otherwise;
I(Positive special itemi,t) 1 if SPIi,t > 0, 0 otherwise;
I(Restatement 1 if firm i announced a restatement during the period starting one day after the
announcementi,t) annual report covering year t-1 is filed and ending on the day that the annual
report covering year t is filed, and did not disclose that the restatement was
prompted by the SEC, and if it was announced by a partner rotation firm in the
post period, the restatement was manually researched to ensure that it does not
relate to the previous years' comment letter conversations, 0 otherwise;
I(Restatement discoveryi,t) 1 if firm i discovered a restatement during the period starting one day after the
annual report covering year t-1 is filed and ending on the day that the annual
report covering year t is filed, and did not disclose that the restatement was
prompted by the SEC, and if it was announced by a partner rotation firm in the
post period, the restatement was manually researched to ensure that it does not
relate to the previous years' comment letter conversations, 0 otherwise;
I(Write-downi,t) 1 if either WDPi,t < 0 or GDWLIPi,t < 0, 0 otherwise;
Intangiblesi,t-1 Firm i's intangible assets for year t-1 scaled by total assets as of the end of year t-
1 (INTANi,t-1 / ATi,t-1);
Inventoryi,t-1 Firm i's change in scaled inventory from year t-2 to year t-1 (INVTi,t-1/ATi,t-1
INVTi,t-2/ATi,t-2);
Inventory allowancei,t Hand-collected ending allowance for inventory obsolescence for firm i in year t,
multiplied by 100, scaled by Adjusted assetsi,t;
Leveragei,t-1 Firm is debt-to-equity ratio at the end of year t-1 ((DD1i,t-1 + DLTTi,t-1)/SEQi,t-1),
winsorized at the 99% quantile and negative values are set to zero;
Loan loss allowancei,t Hand-collected ending allowance for loan losses for firm i in year t, multiplied
by 100, scaled by Adjusted assetsi,t;
Market valuei,t Market value of equity for firm i at the end of year t (CSHOi,t*PRCC_Fi,t);
Non-cash net assetsi,t Non-cash net assets for firm i at the end of year t (ATi,t CHEi,t LTi,t PSTKi,t);
(Continued)
38
Other allowancei,t Hand-collected ending other allowance accounts for firm i in year t, multiplied
by 100, scaled by Adjusted assetsi,t;
Operating incomei,t Firm i's operating income after depreciation in year t divided by its total assets at
year t-1 (OIADPi,t / ATi,t-1), winsorized at 1.0 and -1.0;
POSTi,t 1 in Year 0 and Year 1, 0 in Year -2 and Year -1;
Receivablesi,t-1 Firm is change in scaled receivables from year t-2 to year t-1 (RECTi,t-1/ATi,t-1
RECTi,t-2/ATi,t-2);
Return on assetsi,t Firm i's net income in year t divided by its total assets at year t-1 (NIi,t / ATi,t-1),
winsorized at 1.0 and -1.0;
Return on assetsi,t Change in Return on assets for firm i from year t-1 to year t (Return on assetsi,t -
Return on assetsi,t-1);
Sales returns allowancei,t Ending sales returns allowance for firm i in year t, multiplied by 100, scaled by
Adjusted assetsi,t;
Salesi,t Firm is unscaled sales in year t (SALEi,t);
Soft assetsi,t-1 Firm is soft assets at the end of year t-1 ((ATi,t-1 PPENTi,t-1 CHEi,t-1)/ATi,t-1);
Time in inventoryi,t INVTi,t plus hand-collected ending allowance for inventory obsolescence for firm
i in year t, all scaled by COGSi,t;
Time in receivablesi,t Gross accounts receivable scaled by sales for firm i in year t ((RECTi,t + RECDi,,t)
/ SALEi,t);
Total accrualsi,t-1 Change in firm is Non-cash net assets from year t-1 to year t, scaled by average
total assets ((Non-cash net assetsi,t - Non-cash net assetsi,t-1)/(ATi,t + ATi,t-1)/2);
Total allowancei,t Sum of all ending allowance account balances for firm i in year t, multiplied by
100, scaled by Adjusted assetsi,t; and,
TREATi,t 1 if firm i is a partner rotation firm in time t, 0 otherwise.
This appendix presents variable definitions for all variables in our main analyses. Data notated in all upper-cases are from the
Compustat annual file.
39
APPENDIX B
Panel 1: Example of Comment Letter Response with the Previous Audit Partner
40
Panel 2: Example of Comment Letter Response with the New Audit Partner
41
FIGURE 1
Timeline
This figure presents a timeline to illustrate the process by which partner rotations are identified, and restatement discoveries and announcements and misstatement are assigned to the pre- and
post-rotation periods. The first year in which the new partner is named is Year 0 for our analysis.
42
FIGURE 2
Plots of Financial Reporting Measures by Year Relative to Partner Rotation
0.09
0.06
0.06
Treatment
0.03
0.03
Partner Partner
Rotation Rotation
0.00 0.00
-2 -1 0 1 -2 -1 0 1
0.20 0.30
0.15 0.25
0.10 0.20
Partner Partner
Rotation Rotation
0.05 0.15
-2 -1 0 1 -2 -1 0 1
0.60 0.20
0.55 0.15
Partner Partner
Rotation Rotation
0.50 0.10
-2 -1 0 1 -2 -1 0 1
43
Panel G: Total allowance Panel H: Allowance for doubtful accounts
4.50 0.60
3.50 Control
0.40
2.50 Treatment
Partner Partner
Rotation Rotation
1.50 0.20
-2 -1 0 1 -2 -1 0 1
0.10 0.10
Partner Partner
Rotation Rotation
0.08 0.00
-2 -1 0 1 -2 -1 0 1
2.50
0.15
1.50
Partner Partner
Rotation Rotation
0.50 0.10
-2 -1 0 1 -2 -1 0 1
0.15
Partner
Rotation
0.00
-2 -1 0 1
This figure presents plots of the levels of the financial reporting measures used in our partner rotation analysis. The solid line
presents the level of each measure for partner rotation firms (treatment), and the dotted line presents the level of each measure for
44
matched non-rotation firms (control). For partner rotation firms, Year 0 is the first year the new partner is responsible for auditing
the financial statements, and Year -1 is the last year under the outgoing audit partner.
45
TABLE 1
Sample
46
Panel B: Industry Composition
47
This table presents details of our sample. Panel A illustrates the sample attrition, which primarily occurs because only 4.85
percent of firms have comment letters and copy audit partners by name twice during a three-year window. Panel B presents the
industry composition of our partner rotation sample and the overall Compustat population. Overall, our samples industry
composition is similar to that of Compustat. Our sample lacks representation from some of the smaller industries.
48
TABLE 2
Descriptive Statistics
This table presents the mean and median of all variables in our main tests separately for the partner rotation sample, the matched
non-rotation sample, and the full Compustat sample. Refer to Appendix A for variable definitions.
49
TABLE 3
Conditional Means of Financial Reporting Measures
I(Misstatement) I(Write-down)
TREAT = 1 TREAT = 0 TREAT = 1 TREAT = 0
POST = 0 15.89 15.89 POST = 0 27.65 24.44
POST = 1 13.62 9.54 POST = 1 24.35 21.73
Differences -3.27 -6.35 Differences -3.30 -2.71
50
Deferred tax asset allowance Loan loss allowance
TREAT = 1 TREAT = 0 TREAT = 1 TREAT = 0
POST = 0 1.22 2.98 POST = 0 0.17 0.17
POST = 1 1.74 2.69 POST = 1 0.15 0.13
Differences 0.52 -0.29 Differences -0.02 -0.04
Other allowance
TREAT = 1 TREAT = 0
This table presents the mean of our financial reporting measures for partner rotation firms (TREAT = 1) and non-rotation control
firms (TREAT = 0), in pre-rotation period (POST = 0) and the post-rotation period (POST = 1). Values for I(Restatement
discovery), I(Restatement announcement), I(Misstatement), I(Write-down), I(Negative special item), and I(Positive special item)
are multiplied by 100 so that all variables represent percentages. See Table 1, Panel A for detailed sample sizes and Appendix A
for variable definitions.
51
TABLE 4
Restatements Analysis
Exp. Logit Conditional Logit Exp. Logit Conditional Logit Exp. Logit Conditional Logit
Sign I(Restatement discoveryi,t) Sign I(Restatement announcementi,t) Sign I(Misstatement,t)
TREATi,t * POSTi,t + 0.985** 0.862* + 0.879** 0.741* - 0.367 0.429
(2.31) (1.93) (2.13) (1.72) (1.17) (1.23)
TREATi,t -0.355 -0.248 -0.372 -0.243 0.209 0.369
(-1.30) (-0.78) (-1.33) (-0.76) (1.00) (1.46)
POSTi,t -1.016*** -1.010*** -0.709** -0.698*** -0.537** -0.608**
(-3.32) (-3.11) (-2.46) (-2.30) (-2.30) (-2.36)
Total accrualsi,t-1 -1.114 -2.200 -0.739 -1.680 1.394*** 1.540***
(-1.57) (-2.64) (-1.08) (-2.19) (2.79) (2.61)
Receivablesi,t-1 0.847 1.040 0.322 0.063 -1.738 -2.670
(0.53) (0.50) (0.20) (0.03) (-1.36) (-1.39)
Inventoryi,t-1 -0.334 -0.240 -3.282 -2.770 -2.80 -2.750
(-0.10) (-0.06) (-0.95) (-0.72) (-0.95) (-0.86)
Soft assetsi,t-1 0.089 1.170 0.011 0.857 0.517 0.376
(0.20) (1.45) (0.02) (1.08) (1.39) (0.59)
Leveragei,t-1 0.020 0.027 0.020 0.024 -0.02 0.035
(0.37) (0.33) (0.37) (0.30) (-0.48) (0.66)
I(Issuancei,t-1) 0.687 0.274 0.552 0.263 0.741* -0.126
(1.29) (0.42) (1.05) (0.41) (1.65) (-0.24)
Return on assetsi,t-1 1.080 1.170 0.957 0.900 0.661 0.787
(1.64) (1.38) (1.49) (1.09) (1.23) (1.16)
Return on assetsi,t-1 -1.124* -1.420 -1.363** -1.520 -1.733*** -1.880**
(-1.68) (-1.40) (-2.05) (-1.58) (-3.05) (-2.23)
I(Big 4 auditori,t-1) -0.395 -0.660 -0.487 -0.738 -0.469* -1.170***
(-1.14) (-1.06) (-1.44) (-1.20) (-1.82) (-2.59)
Agei,t 0.002 0.003 -0.001 -0.003 0.003 0.009
(0.21) (0.22) (-0.15) (-0.22) (0.48) (0.83)
Book to marketi,t-1 0.158 0.232 0.219 0.408 0.165 -0.171
(0.41) (0.39) (0.58) (0.69) (0.54) (-0.38)
log(Market valuei,t) -0.133** -0.308** -0.110* -0.304** -0.061 -0.071
(-2.05) (-2.09) (-1.71) (-2.10) (-1.24) (-0.70)
SEC office fixed effects Included Included Included Included Included Included
N 1,502 1,502 1,502 1,502 1,502 1,502
Psuedo R2 0.07 0.15 0.06 0.13 0.06 0.09
52
This table presents logit and conditional logit regression results examining the effect of partner rotation on restatements. Conditional logit regressions are estimated using matched
pairs as strata. The "Exp. Sign" column indicates "+" where we hypothesize the coefficient to be positive and "-" where we hypothesize the coefficient to be negative. N reports the
number of firm-year observations. *,**,*** indicate significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed p-values. Z-statistics are reported in parentheses
below the coefficients. Refer to Appendix A for variable definitions.
53
TABLE 5
Write-downs and Special Items Analysis
Exp. Logit Conditional Logit Exp. Logit Conditional Logit Exp. Logit Conditional Logit
Sign I(Write-downi,t) Sign I(Negative special itemi,t) Sign I(Positive special itemi,t)
TREATi,t * POSTi,t + -0.019 -0.074 + 0.331 0.369 - -0.672** -0.692**
(-0.08) (-0.28) (1.58) (1.62) (-2.50) (-2.46)
TREATi,t 0.236 0.380** -0.199 -0.202 0.253 0.160
(1.42) (2.04) (-1.36) (-1.25) (1.28) (0.76)
POSTi,t -0.249 -0.299 -0.188 -0.192 0.645*** 0.677***
(-1.42) (-1.56) (-1.26) (-1.18) (3.39) (3.36)
Intangiblesi,t-1 2.072*** 1.967*** 2.372 1.736*** -0.597* -0.487
(7.48) (4.07) (8.60) (4.11) (-1.76) (-0.98)
I(Book-to-marketi,t-1 > 1) 0.722*** 0.924*** -0.125 0.016 0.209 0.139
(4.66) (4.33) (-0.87) (0.09) (1.20) (0.61)
Operating incomei,t -1.998*** -2.479*** -0.617 0.141 -1.009* -1.642*
(-3.35) (-2.72) (-1.37) (0.22) (-1.65) (-1.92)
log(Market valuei,t) 0.076** -0.139* 0.058** -0.052 0.081** 0.365***
(2.31) (-1.75) (2.09) (-0.82) (2.25) (4.05)
This table presents logit and conditional logit regression results examining the effect of partner rotation on write-downs and special items. The coefficients on TREATi,t*POSTi,t indicate that
partner rotation is associated with a marginal increase in I(Negative special item) and a significant decrease in I(Positive special item). Conditional logit regressions are estimated using matched
pairs as strata. The "Exp. Sign" column indicates "+" where we hypothesize the coefficient to be positive and "-" where we hypothesize the coefficient to be negative. N reports the number of
firm-year observations. *,**,*** indicate significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed p-values. Z-statistics are reported in parentheses below the coefficients.
Refer to Appendix A for variable definitions.
54
TABLE 6
Allowances Analysis
55
Panel B: Deferred tax asset allowance increase vs. decrease
Rotation Firms Non-Rotation Firms Difference
Percent Increase 60.92 46.79 14.13**
Percent Decrease 39.08 53.21 -14.13**
N 196
Pseudo R2 0.16
Panel A presents OLS regression results examining the effect of audit partner rotation on valuation allowance and reserve accounts. The positive and significant coefficients on TREATi,t*POSTi,t
for Total allowance and Deferred tax asset allowance indicate that partner rotation has influence on the clients total allowances, and in particular the deferred tax valuation allowance. Fixed
effects are included for each matched pair. The "Exp. Sign" column indicates "+" where we hypothesize the coefficient to be positive. N reports the number of firm-year observations. *,**,***
indicate significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed p-values. T-statistics are reported in parentheses below the coefficients. The sample size in this analysis is
smaller than those used in Tables 4 and 5 because not all firms provide the necessary allowance disclosures. Panel B presents the percent of firms whose deferred tax asset allowance balances
increase or decrease from the pre-period (POST = 0) to the post-period (POST = 1), such that there is one observation per four-year period; observations without deferred tax assets are excluded.
T-tests for difference in means are presented in the Difference column. ** indicates statistical significance at the 0.05 level using two-tailed p-values. Panel C presents logit regression results
predicting an indicator variable which is equal to 1 when the mean Deferred tax asset allowance increases from the pre-period (POST = 0) to the post-period (POST = 1), and 0 otherwise,
such that there is one observation per four-year period; observations without deferred tax assets are excluded. **, *** indicate significance at the 0.05, and 0.01 levels, respectively, using two-
tailed p-values where there is no prediction. Z-statistics are reported in parentheses to the right of the coefficients. Refer to Appendix A for variable definitions.
56
TABLE 7
Additional Analyses - Unambiguous Non-Rotation Sample
Exp. Logit Conditional Logit Exp. Logit Conditional Logit Exp. Logit Conditional Logit
Sign I(Restatement discoveryi,t) Sign I(Restatement announcementi,t) Sign I(Misstatementi,t)
TREATi,t * POSTi,t + 1.376*** 1.380** + 0.946* 0.972* - 0.440 0.600
(2.62) (2.48) (1.89) (1.85) (1.16) (1.36)
Exp. Logit Conditional Logit Exp. Logit Conditional Logit Exp. Logit Conditional Logit
Sign I(Write-downi,t) Sign I(Negative special itemi,t) Sign I(Positive special itemi,t)
TREATi,t * POSTi,t + 0.062 0.036 + 0.221 0.257 - -0.400 -0.422
(0.22) (0.12) (0.87) (0.93) (-1.20) (-1.19)
57
Panel D: Allowances Analysis Deferred tax asset allowance increase vs. decrease (n = 134, 62 Rotations)
Panel E: Allowances Analysis Predicting an increase in the deferred tax asset allowance (n = 134, 62 Rotations)
Logit
Exp. I(Increase DTAi)
Sign Coeff. z-statistic
TREATi + 0.836** (2.02)
Pseudo R2 0.18
This table presents additional analyses in the subset of matched pairs for which the non-rotation firm has exactly the same auditor names copied in the pre-period (POST = 0) to the post-period
(POST = 1). Panel A presents logit and conditional logit regression results examining the effect of partner rotation on restatements, similar to the analysis in Table 4, and we include all control
variables. Conditional logit regressions are estimated using matched pairs as strata. Z-statistics are reported in parentheses below the coefficients. Panel B presents logit and conditional logit
regression results examining the effect of partner rotation on write-downs and special items, similar to the analysis in Table 5, and we include all control variables. Conditional logit regressions
are estimated using matched pairs as strata. Z-statistics are reported in parentheses below the coefficients. Panel C presents OLS regression results examining the effect of audit partner rotation
on valuation allowance and reserve accounts, similar to the analysis in Table 6 Panel A, and we include all control variables. Fixed effects are included for each matched pair. T-statistics are
reported in parentheses below the coefficients. Panel D, similar to the analysis in Table 6 Panel B, presents the percent of firms whose deferred tax asset allowance balances increase or decrease
from the pre-period (POST = 0) to the post-period (POST = 1), such that there is one observation per four-year period; observations without deferred tax assets are excluded. T-tests for difference
in means are presented in the Difference column. Panel E, similar to the analysis in Table 6 Panel C, including all control variables, presents logit regression results predicting an indicator
variable which is equal to 1 when the mean Deferred tax asset allowance increases from the pre-period (POST = 0) to the post-period (POST = 1), and 0 otherwise, such that there is one
observation per four-year period; observations without deferred tax assets are excluded. Z-statistics are reported in parentheses to the right of the coefficients. The "Exp. Sign" columns indicate
"+" where we hypothesize the coefficient to be positive and "-" where we hypothesize the coefficient to be negative. N reports the number of firm-year observations. *, **, *** indicate
significance at the 0.10, 0.05, and 0.01 levels, respectively, using two-tailed p-values. Refer to Appendix A for variable definitions.
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