Mandatory audit partner rotation and stock price crash risk: causal evidence from a natural experiment

Abstract

Purpose This study aims to examine whether mandatory audit partner rotation is associated with future stock price crash risk. Design/methodology/approach This study makes use of a regulatory change from the Ministry of Finance of China and the China Securities Regulation Commission, which requires mandatory rotation of audit partners since 2004, as a natural experiment to establish causality and applies a difference-in-difference research design. Findings Audit partner rotation leads to a significant decrease in future stock price crash risk in the departing partner’s final year of tenure preceding mandatory rotation, consistent with peer monitoring argument of mandatory rotation. Inconsistent with other arguments, including client-specific knowledge, fresh perspective and auditor independence, no significant effect takes a place in the incoming partner’s first year of tenure following mandatory rotation. Mechanism analysis documents that mandatory audit partner rotation reduces stock price crash risk by improving audit quality and constraining managerial empire building. Originality/value The results shed new light on the capital market consequence of mandatory audit partner rotation and the cause of stock price crash risk.