An overlooked effect of mandatory audit–firm rotation on investigation strategies

Section 207 of the Sarbanes–Oxley Act of 2002 (hereafter, the SOX Act) passed by the US Congress requires a study of mandatory auditor rotation of registered public accounting firms. In the debate over the costs and benefits of mandatory audit–firm rotation, one cost has been overlooked: that of more aggressive monitoring. Because few countries have put such mandatory rotation into practice, there is little empirical evidence available for analysis of its costs and benefits. My research, therefore, uses an analytical approach to demonstrate that, in a firm that has a well‐functioning independent board, as required by section 301 of the SOX Act, the board will adopt a more aggressive strategy in investigating the collusion between the manager and the auditor and pay a higher audit fee than it would have done in an environment with no audit–firm rotation requirement. The results of this research alter the balance between the costs and benefits of a mandatory audit–firm rotation requirement and should not be ignored by regulators considering implementing such a requirement.