Does Mandatory Auditor Rotation Increase Audit Quality? A Test of Indonesian Ministry of Finance’s Decree Effectiveness

We investigate whether auditor's mandatory rotation affects audit quality. In specific, we test the effectiveness of Ministry of Finance's (MOF) decree no. 423/2002. Following some other studies that investigate audit quality, we use discretionary accruals as the proxy for audit quality. Our test result suggests that audit quality is lower after the rotation than before the rotation. This result is surprisingly unexpected since we expect post-rotation auditor will be more skeptical and more conservative to its new client and, therefore, will push the discretionary accrual down. We conjecture that auditors have anticipated the MOF decree for two reasons. Firstly, more than half of our sampled rotations (58%) take place on 2002 or 85% of sampled firms by 2003. It indicates that companies and their auditors have anticipated this decree. Secondly, some local accounting firms dissolve their partnerships and re-establish a new one while both of them retaining their foreign associates. If the pre- and post-mandatory auditors are in fact the same accounting firm, since they have the same foreign affiliation, there is no surprise that we will not observe some changes in the audit the quality. In this research, we, however, consider this switch as a mandatory rotation since lawfully the company is audited by different auditor. Our samples are suffers from this limitation