Legitimizing Mandatory Rotation: A glimpse into mandatory rotation and its expected implications in Germany and Sweden

Abstract

Background and Problem: In the aftermath of the global financial crisis and a series of corporate scandals in recent years legislators have discussed mandatory audit firm rotation as a mean to ensure auditor independence and to promote audit quality. New regulations have been pushed forward by the European Commission and a rotation requirement had to be implemented by all EU member states until June 2016. Yet, opinions about mandatory audit firm rotation are rather split and there has been significant opposition against the regulation. According to legitimacy theory a legitimacy gap occurs, if society’s expectations and an organization’s activities are not aligned. The discourse on mandatory rotation can therefore be seen as a debate about the legitimacy of auditing itself. Purpose: This study aims to investigate how legitimacy is created in Sweden and Germany around the recently implemented regulation on mandatory rotation of audit firms by analysing the arguments made in the debate on mandatory rotation. It aims to to provide a better understanding of the regulation and to indicate the implications of mandatory rotation on auditor independence, audit quality and competition as seen by market participants and practitioners in Germany and Sweden. Research Design: In order to address the research problem a qualitative study was conducted. It firstly comprises a document analysis of a series of EU documents together with a selection of comment letters from affected third parties from Germany and Sweden. This was then enriched with four interviews with practitioners in Sweden. The study therefore relies on Whittle et al.’s (2014) framework regarding discursive strategies to illustrate the arguments made in the discourse on mandatory rotation. Discussion and Conclusion: Mandatory rotation has sparked a fierce debate about its implications for auditors and businesses. Contrary to the objectives of the European Commission, this study suggests that it might not achieve its three main objectives in Germany and Sweden as the findings on the one hand highlight a tendency to question the positive effect on the independence in mind and on the other hand emphasize a potentially negative effect on competition in both countries. However, independence in appearance is increasing with the new regulations and only future research will reveal the cost implications of mandatory rotation, which might ultimately decide about the success of the reform.