kaplan and mauldin - 2008 - auditor rotation and the appearance of independence - evidence from non-professional investors

Auditor rotation and the appearance
of independence: Evidence from
non-professional investors
Steven E. Kaplan
a,
*
, Elaine G. Mauldin
b,1
a
W.P. Carey School of Business, Arizona State University, Tempe, AZ 85287-3606, USA
b
Robert J. Trulaske, Sr. College of Business, 331 Cornell Hall, University of Missouri, Columbia, MO 65211, USA
Abstract
We examine the impact of audit firm versus partner rotation on non-professional investors’ inde-
pendence-related perceptions, extending prior research on auditor rotation and independence in fact.
Arguments for mandatory audit firm rotation continue to be made by regulators and investor groups
based, in part, on the idea that firm rotation will incrementally strengthen independence in appear-
ance relative to audit partner rotation. We report the results of two experiments. The first examines
5-year audit firm versus partner rotation under relatively weak or strong audit committees. We find
no statistically significant difference in beliefs about how much of an income reducing audit differ-
ence management will record, or in beliefs about auditor independence, between the two auditor
rotation conditions. On the other hand, we find that non-professional investors do believe more
of the audit difference will be recorded, and the auditors will be more independent, under a strong
audit committee than a relatively weak audit committee. The second experiment provides further evi-
dence on audit firm versus partner rotation by examining a setting involving a 26-year audit firm–
client relationship. Again, no statistically significant differences between the two auditor rotation
conditions were found. These findings suggest that compared to audit partner rotation, audit firm
rotation does not strengthen independence in appearance among non-professional investors and that
non-professional investors recognize the value of strong audit committees.
Published by Elsevier Ltd.
Keywords: Auditor rotation; Auditor independence; Audit committee; Investor judgment

0278-4254/$ - see front matter Published by Elsevier Ltd.
doi:10.1016/j.jaccpubpol.2008.01.004
*
Corresponding author. Tel.: +1 480 965 6498; fax: +1 480 965 8392.
E-mail addresses: (S.E. Kaplan), (E.G. Mauldin).
1
Tel.: +1 573 884 0933.
Available online at www.sciencedirect.com
Journal of Accounting and Public Policy 27 (2008) 177–192
www.elsevier.com/locate/jaccpubpol
1. Introduction
The importance of auditor independence, in fact and in appearance, is widely accepted
in theory and practice (Nelson, 2006). Many contend that regulations permitting an unlim-
ited period of association between audit firms and their clients represent a threat to inde-
pendence (Moore et al., 2006; Raiborn et al., 2006; Sinnett, 2004). Provisions of the
Sarbanes Oxley Act of 2002 (SOX) mandate the rotation of the lead audit partner, but
not the audit firm itself, every 5 years. However, because of concerns about the threat
to auditor independence, SOX also directed the United States General Accounting Office
(GAO) to study the expected effects of mandatory audit firm rotation. The report issued
by the GAO indicates that audit firm rotation may strengthen the appearance of indepen-
dence among financial statement users, but that the evidence is limited and indirect and
calls for additional resear ch on the topic (GAO, 2003).
We contribute to this policy issue by reporting the results of two experiments that pro-
vide evidence on whether audit firm rotation, relative to the currently required audit part-
ner rotation, strengthens the appearance of independence as reflected in non-professional
investors’ perceptions.
2
The first experiment also includes two levels of audit committee
strength, strong or relatively weak. Auditors work for and with the audit committee
and both are part of the corporate governance mosaic (Cohen et al., 2004). By manipulat-

ing this variable, we are ab le to provide evidence on whether a strong audit committee
strengthens non-professional investors’ independence-related perceptions as well as
whether the ability of audit firm rotation to enhance these perceptions depends, in part,
on the strength of the audit committee. In this experiment, the audit firm–client relation-
ship is five years, mimicking the current ly required partner rotation. However, the ability
of audit firm rotation, relative to audit partner rotation, to enhance non-professional
investors’ independence-related perceptions may depend on the length of the audit firm–
client relat ionship. In the second experiment, we consider a relatively long audit firm–cli-
ent relationship where the current year is year 26 of the relationship.
In both experiments, MBA students representing non-professional investors were given
a case (based on Libby and Kinney, 2000) describing the discovery of an income decreas-
ing audit difference by the auditor and were asked to indicate the earnings the company
would report, implicitly judging how much of the audit difference would be corrected in
the final audited financial statements. The tension in the case is based on an earning s man-
agement issue;
3
if the entire amount of the audit difference is recorded, the company will
miss analysts’ forecasts by $.02, providing management incentive to not record the entire
amount. Theoretically, auditors perceived as more independent should be perceived as
more likely to ‘‘stand up” to management when engaging in earnings management, result-
ing in beliefs that more of the income decreasing audit difference will be recorded, ceteris
2
We focus on non-professional investors’ perceptions because these perceptions are considered crucial to
capital markets’ efficiency and effectiveness (SEC, 2001; Vickers and McNamee, 2002), especially with recent
increases in the number of non-professional investors (Securities Industry Association, 2002; SEC, 2003) and
because investor confidence continues to be a pressing concern for management as well as regulators (PWC,
2005).
3
Earnings management, defined as managers altering financial reports to mislead investors about the
underlying economic performance of the company (Healy and Wahlen, 1999), is a concern for regulators desiring

to protect the credibility of financial statements (Levitt, 1998).
178 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
paribus (DeZoort et al., 2003). Consequently, we examine both perceived auditor indepen-
dence and earnings beliefs.
In the first experiment, we find that participants’ earnings beliefs, and perceived auditor
independence, were not significantly different under audit firm or partner rotation, regard-
less of audit committee strength. In the second experiment, we continue to find no signif-
icant difference in participants’ earnings beliefs or auditor independence perceptions
between audit firm and partner rotation. These results are consistent with archival
research on independence in fact (Myers et al., 2003; Johnson et al., 2002) and suggest
that, among non-professional investors, independence in appearance is not affected by
audit firm compared to audit partner rotation. On the other hand, the results from the first
experiment show that participants’ belie fs about reported earnings were lower, and per-
ceived auditor independence was higher, in the presence of a strong audit committee, com-
pared to a relatively weak audit committee. These results indicate that audit committees
adopting best practices provide perceptual benefits, enhancing the auditors’ perceived
independence among non-professional investors.
This study contributes to both research and policy setting. For research, the study pro-
vides direct evidence on perceptions about the appearance of independence from non-pro-
fessional investors. The task of forming a judgment about how much of an audit difference
will be recorded is especially useful because it provides evidence about investors’ beliefs
that are not otherwise avail able. Thus, the study complements archival research exploring
the role of corporate governance mechanisms in improving financial reporting credibility.
For policy setting, the study provides ex ante experimental evidence, not available in archi-
val studies, about the impact one might expect from mandating audit firm rotation. Such
ex ante evidence should be useful to policymakers as they further consider the need for
mandated audit firm rotation.
The following sectio n reviews prior literature and develops research questions. Then,
the experimental design is described and the results are presented. The last section dis-
cusses the results and provides concluding comments.

2. Background
Independent external audits play a central role in the financial reporting process of pub-
lic companies, adding credibility to the financial statement s (Watts and Zimmerman,
1986). Auditing standards historically include independence in fact and in appearance
(AICPA, 1972). Because independence in fact is unobservable, investors’ perceptions mat-
ter and perceived lack of independence can be as damaging as an actual violation of inde-
pendence (Olazabal and Almer, 2001). The importance of investors’ perceptions is often
recognized in regulatory actions such as SOX, which was passed, in part, to restore inves-
tor confidence.
2.1. Auditor rotation
Hoyle (1978) traces periodic interest in audit firm rotation from the 1939 Congressional
investigation into the McKesson and Robbins fraud case to the 1976 issuance of the Met-
calf report and investor activists’ testimony calling for audit firm rotation. These calls con-
tinue to be made by some researchers (Moore et al., 2006), investor groups (Sinnett, 2004),
and major pension fund managers, including TIAA –CREF and Calpers (Marshall, 2002),
S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 179
as a way to protect against threats to auditor independence. Historically, audit firms and
organizations, have argued against mandatory audit firm rotation asserting that other pro-
tections, such as reputation and legal liability, are sufficient to maintain investor confi-
dence (AICPA, 1992).
The GAO’s report (2003) concluded that the currently required audit partner rotation
enhances auditor independence in fact as well as audit firm rotation,
4
but indicated that
mandatory audit firm rotation may yet be necessary to strengthen auditor independence
in appearance (GAO, 2003). This conjecture, was based, in part, on the results from a sur-
vey of key stakeholders, where 65% (38%) of the public company (public accounting firm)
members responded that mandat ory audit firm rotation would strengthen pe rceptions of
auditor independence (GAO, 2003). However, this survey evidence does not directly rep-
resent the belie fs of investors. In an experimental study, Jennings et al. (2006) find that

judges perceive higher auditor independence when the firm was rotated than when the
partner was rotated, but again this does not directly represent the beliefs of investors.
5
Recently, Raiborn et al. (2006, 39) contends that, relative to audit partner rotation, man-
datory audit firm rotation ‘‘would increase the public perception of auditor independence”
(italics from original).
Threats to auditor independence may theoretically stem from sociological or economic
pressures. Under economic theory, audit firms have an economic incentive to keep an
ongoing relationship with an au dit client in order to obtain profits from future audits.
Regarding independence in fact, when the audit firm anticipates an ongoing future rela-
tionship the audit firm may audit less vigilantly and be more predisposed to go along with
aggressive and/ or questionable accounting methods to protect their stream of quasi-rents
(Watts and Zimmerman, 1986). Mandating audit firm rotation limits the stream of profits
from future audits, lessening the economic incentives for the audit firm to act in a less than
independent fashion. By lessening these economic incentives, mandating a limited time
horizon is expected to strengthen perceptions of auditor independence. The impact of less-
ening economic incentives must occur at a firm level to be effective since all partners (cur-
rent and rotating) are likely to be impacted by the firm’s economic incentives.
Under a sociological perspective, Moore et al. (2006) introduce the term ‘‘moral seduc-
tion” to describe how, over time, clients exert a ‘‘gradual accumulation of pressures” to
‘‘encourage complacency among practitioners” such that auditors will be more likely to
‘‘slant their conclusions” (Moore et al., 2006, 11). Bamber and Iyer (2007) provide evi-
dence consistent with this concern on an individual auditor basis. Their study shows that
the length of auditors’ tenure with a client is associated with the extent to which auditors
identify with a client, which in turn, is associated with greater acceptance of client pre-
ferred outcomes .
To examine the contention that audit firm rotation strengthens the ap pearance of inde-
pendence, we use a situation in which management has incentives to manage earnings to
4
Arel et al. (2006) and Hatfield et al. (2006) provide some evidence on auditor rotation and independence in

fact. Arel et al. (2006) find that experienced auditors believed their audit firm would be more likely to issue a
modified audit report under firm rotation than no rotation. Hatfield et al. (2006) also find positive results
comparing firm to no rotation, but find that audit partner versus audit firm rotation results in similar judgments.
5
It is also worth noting that the case included information that non-audit services were more than three times
the audit fee. It is possible that judges’ perceptions of auditor independence may interact with the level of non-
audit fees and that their findings may not generalize to a setting with lower non-audit service fees.
180 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
meet or beat the analysts’ consensus forecast and the auditors have identified an unre-
corded accounting difference. If audit firm rotation strengthens the appearance of indepen-
dence by reducing perceived economic and/or sociological pressures compared to audit
partner rotation, then non-professional investors will perceive higher auditor indepen-
dence and will expect reported earnings to be lower, stated as follows:
Research question 1a: Will non-professional investors expect reported earnings to be
lower when the audit firm is rotated than when the audit partner is rotated?
Research question 1b: Will non-professional investors perceive the auditor more inde-
pendent when the audit firm is rotated than when the aud it partner is rotated?
2.2. Audit committee strength
Prior research suggests that the role of the audit firm is complex because the firm inter-
acts with both the audit committee and management ( Cohen et al., 2004 ). The audit com-
mittee appoints the audit firm and oversees the financial reporting process, including
resolving any differences between management and the audit firm. Prior research generally
supports the idea that stronger audit committees are associated with positive financial
reporting outcomes (Abbott et al., 2004; DeZoort and Salterio, 2001; Xie et al., 2003)
and also finds that strong er audit committees are positively associated with greater sup-
port for the auditor’s posit ion on accounting issues (DeZoort and Salterio, 2001; DeZoort
et al., 2003). If a strong audit committee strengthens the appearance of independence, then
non-professional investors will perceive higher auditor independence and will expect
reported earnings to be lower, stated as follows:
Research question 2a: Will non-professional investors expect reported earnings to be

lower when the audit committee is strong than when it is relatively weak?
Research question 2b: Will non-professional investors perceive the auditor more inde-
pendent when the audit committee is strong than when it is relatively weak?
The extent to which audit firm rotation enhances independence-related perceptions
might interact with the strength of the audit committee because both the audit firm and
the audit committee are components of the firm’s corporate governance system (Cohen
et al., 2004). It might be the case that any perceptual benefits might diminish when the
audit committee is strong. The audit committee would presumably be expected to closely
monitor the work of the audit firm, such that the form of audit rotation would no longer
be consequentia l. For example, in a case involving the discovery of fraud triggering sub-
stantial decline in the stock price, Jennings et al. (2006) find that judges’ auditor liability
perceptions were less when the firm was rotated compared to partner rotation, but only
under conditions of relatively weak corporate governance. On the other hand, for inves-
tors a strong audit committee may interact with audit firm rotation to provide even higher
perceptions of independence. This discussion leads to our final research question, stated as
follows:
Research question 3a: Will the effect of auditor rotation on non-professional investors’
reported earning s beliefs be different when the audit committee is strong than relatively
weak?
S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 181
Research question 3b: Will the effect of auditor rotation on non-profes sional investors’
perceptions of auditor independence be different when the audit committee is strong
than relatively weak?
3. Methodology and results for Experiment 1
3.1. Procedures and task
We first conducted a 2 Â 2 between-participants experiment that manipulated auditor
rotation and audit committee strength. Experimental materials included a cover sheet, case
materials, and additional questions. The cover sheet requested participation and provided
general instructions including a guarantee of anonymity and a definition of an audit
difference.

The case materials, developed from Libby and Kinney (2000), first described a medium-
sized publicly traded auto parts manufacturer, Capital Auto Parts (CAP). Information
about the company, pre-audit financial statement balances, earnings per share (EPS),
and analysts’ consensus forecast was constant across all treatments. The case also
described the discovery of an audit difference related to management’s estimate of the
inventory obsolescence allowance, stating: ‘‘the auditor believes that the recorded allow-
ance is outside a reasonable range by an amount that overstates current earnings per share
by $.03. ” The case was designed such that under traditional be nchmarks the audit differ-
ence would be considered quantitatively immaterial (Brody et al., 2003). However, fully
adjusting earnings for the audit difference would result in earnings $.02 below the analysts’
forecast, providing a context where management has incentives to not record the audit
difference.
After reading the case, each participant indicated ‘‘the most likely EPS amount CAP
would finally report in the audited financial statements for the year” by circling one of four
amounts ranging from $1.07 (all the audit difference correct ed) to $1.10 (none of the audit
difference corrected). We use responses to this question, the earnings belief, as the first
dependent measure. For the secon d dependent measure, perceived auditor independence,
we use responses from one question in the additional questions where participants were
asked to assess the independence of CAP’s auditor on a seven point response scale
anchored by ‘‘low independence” (coded 1) and ‘‘high independence” (coded 7). Other
additional questions included questions about the manipulated variables, and the partic-
ipant’s background and attitudes .
3.2. Treatment variables
For the auditor rotation treatment, participants were randomly assigned to one of two
conditions, partner or firm rotation. Reflecting current regulation, the partner rotation
condition indicated the external audit firm rotates the audit partner in charge of the
engagement every 5 years. For the firm rotation condition, the case indicated the audit
committee has a policy of rotating the external audit firm every 5 years. This time frame
was chosen to be consistent with the partner rotation condition and with various investor
and legislative proposals recommending firm rotation every 5–7 years (Moore et al., 2006;

Zeff, 2003; Marshall, 2002; Hoyle, 1978). This time frame is also within the range of man-
datory audit firm rotation exist ing outside the United States (Zeff, 2003). Regarding the
182 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
year in the rotation cycle, the case indicated that since this was the audit partner’s (external
audit firm’s) fifth year with the client, a new audit partner (external audit firm) would take
over the engagement next year. Setting the case in the last year prior to rotation is consis-
tent with Arel et al. (2006). In the year prior to rotation the audit partner and firm has the
least to lose in terms of future quasi rents (DeAngelo, 1981).
For the audit committee strength treatment, participants were randomly assigned to
either a strong or relatively weak audit committee condition. Though SOX included sev-
eral provisions meant to strengthen the effectiveness of audit committees,
6
they fell short of
the Blue Ribbon Committee (BRC) on Improving the Effectiveness of Corporate Audit
Committees’ recommendations (BRC, 1999). Some companies have adopted the best prac-
tices identified by the BRC that go be yond the requirements of SOX (Spencer Stuart,
2003). We based our strong audit committee condition on the BRC recommendations.
To maintain realism, however, both treatments were designed to be within current
regulations.
Based on previous research (DeZoort et al., 2002; Cohen et al., 2004), the manipulation
of audit committee strength incorporates multiple measures. DeZoort et al. (2002) contend
that overall audit committee effectiveness is multi-dimensional, including composition
(financial expertise and independence), diligence (number of meetings
7
), resources (num-
ber of members and the committee’s access to management, external auditors, and internal
auditors), and authority (committee responsibilities). Under the strong audit committee
treatment, all five members of the audit committee were independent outside directors
who also were financial experts as defined by the SEC (and two of the members were
CPAs). Further, the audit committee met with senior members of management, the vice

president of internal audit, and the external auditors in private, separate sessions six times
during the year. In contrast, under the relatively weak audit committee treatment, all three
audit committee members were independent outside directors, but only one was consid-
ered a financial expert as defined by the SEC and none had a background in either
accounting or finance. Further, the audit committee met only once a year, together with
senior members of management as well as the vice president of internal audit and the inde-
pendent auditors.
8
Audit committee authority was held constant.
3.3. Manipulation checks and demographics
Participants were 163 MBA students who were randomly assi gned to treatment condi-
tions and completed the experiment in class with one of the authors present.
9
Two of
the additional questions were used to test participants’ understanding of the treatment
6
Section 301 requires all committee members to be independent of management and that the audit committee is
directly responsible for the appointment, compensation, and oversight of the external auditor. Section 407
requires companies to disclose the audit committee member(s) that is a financial expert or indicate the absence of
a financial expert on the audit committee.
7
More frequent meetings are associated with higher effort (DeZoort et al., 2002).
8
Neither SOX nor Nasdaq listing requirements specify either a required frequency of meetings or who should
be included in the meetings. The NYSE listing requirements also do not specify meeting frequency but, since
November 2004, do specify that the audit committee should meet separately with management, the internal
auditors, and the external auditors. The experimental instrument specifies that the audit committee is ‘‘compliant
with current regulations” implicitly placing the company in a Nasdaq setting.
9
Four students did not complete the case questionnaire and were dropped from the study.

S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 183
variables, auditor rotation and audit committee strength. For the analyses shown, partic-
ipants incorrectly answering either of the manipulation check questions (38) were dropped
because of a lack of ‘‘inclusion importance” (Yates, 1990, p. 376). As Tan and Yates (1995,
p. 315) contend: ‘‘if a decision maker never acknowledges the existence of a particular
dimension, then the decision maker cannot possibly respond to that dimension”. There
is no significant difference in the number of participants dropped between conditions.
When all participants are included in the analyses (not shown), the significance, or lack
thereof, of each variable remains the same.
Table 1, Panel A, presents a demographic profile of the 125 participants included in the
results. Participants’ mean age was about 30 and their mean work experience was about 7
years. The majority of participants was male and owns or has owned stock. Participants’
mean rating of their own ability to understand financial reporting was above the mid-
point. This demographic profile suggests that the participants are capable of completing
the task and are a reasonable proxy for non-professional investors. There is no significant
difference across treatment condition for any of the demographic variables (p > .10) sug-
gesting that randomization of participants to condition was effective. In sensitivity analy-
ses, not shown, we include each of the background variables as a control variable in the
models reported in the results. The only variable that is significant is age and the reported
results are unaffected so we do not report these covariates.
Table 1, Panel B, presents a profile of participants’ attitudes relevant to materiality of
the audit difference, task realism and importance. As shown, participants’ mean asses s-
ment of materiality was 5.31, on the highly material end of the scale suggesting that par-
ticipants understood the impact of the audit difference on the company’s ability to meet
the forecast. Participants’ mean rating of task realism was 5.00, above the mid-point of
the seven-point scale. Finally, participants indicated that their assessments of financial
statement reliability influenced their investment decisions (mean 5.84), suggesting their
beliefs about financial reporting outcomes are important. There is no significant difference
across treatment condition for these attitude variables (p > .10) further suggesting that
randomization of participants to conditions was effective. Again, sensitivity analyses

Table 1
Experiment 1 – Profile of 125 participants’ background and attitudes
Mean Std.
dev.
Minimum Maximum
Panel A: Profile of participants’ background
Age 29.58 4.71 18 46
Years of professional work experience 6.88 4.52 0 25
Gender (0, male or 1, female) .33 .47 0 1
Experience owning stock (0, no or 1, yes) .88 .35 0 1
Ability to understand financial reporting (1, very low to 7, very
high)
4.68 1.20 1 7
Panel B: Profile of participants’ task attitudes
Materiality of audit difference (1, not material at all to 7, highly
material)
5.31 1.43 2 7
Task realism (1, very unrealistic to 7, very realistic) 5.09 1.17 1 7
My assessment of the trustworthiness or reliability of the annual
audited financial statements strongly influences my investment
decision (1, strongly disagree to 7, strongly agree)
5.84 2.06 1 7
184 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
(not shown) reveal no effects on the reported results when the varia bles are each included
as controls in the reported models.
3.4. Analyses of research questions
General linear model analysis of variance (GLM) is used to present evidence relative to
the research questions because it is appropriate for testing unbalanced designs (Milliken
and Johnson, 1992). In the first analysis, the de pendent variable is the participant’s earn-
ings belief.

10
The independent variables are auditor rotation (partner or firm), audit com-
mittee strength (strong or relatively weak), and the inter action term. Table 2, Panel A
presents descriptive statistics by condition for the dependent variable and Panel B presents
multivariate results.
Table 2
Experiment 1 – Analysis of auditor rotation and audit committee strength on most likely reported (audited) EPS
a
Panel A: Descriptive statistics
Audit committee strength Auditor rotation
Partner Firm Overall
Relatively weak NNN
Mean Mean Mean
(Median) (Median) (Median)
STD STD STD
35 30 65
1.085 1.088 1.086
(1.090) (1.090) (1.090)
.013 .012 .013
Strong 28 32 60
1.080 1.082 1.081
(1.070) (1.080) (1.070)
.012 .013 .012
Overall 63 62 125
1.083 1.085 1.084
(1.080) (1.090) (1.090)
.013 .013 .013
Panel B: GLM ANOVA – Most likely reported EPS
Effect df F Prob. Research question
Auditor rotation 1 1.38 .24 1a

Audit committee strength 1 5.54 .02 2a
Auditor rotation by audit committee strength 1 .04 .83 3a
Error 121
a
Most likely reported (audited) EPS is either $1.07, $1.08, $1.09, or $1.10.
10
Two other analyses were used to test the sensitivity of the results to alternative specifications (not shown).
First, we transformed the dependent variable to ranks and re-performed the GLM analysis reported. Second,
using logistic regression, the dependent variable was calculated as a dichotomous variable taking the value of one
for reported EPS of $1.09 or $1.10 (meet or beat analysts’ forecast) and zero for reported EPS of $1.07 or $1.08
(miss analysts’ forecast). The statistical results of both sensitivity analyses are substantially equivalent to those
reported.
S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 185
Research question 1a asks whether earnings beliefs will be lower when the audit firm is
rotated compared to when the audit partner is rotated. As shown in Table 2 Panel A, mean
(median) estimated EPS is 1.083 (1.08) and 1.085 (1.09) under the audit partner and audit
firm rotation , respectively. Neither the means nor the medians are significantly different
(p > .10), indicating audit firm rotation is not perceived to constrain earnings management
to a great er extent than audit partner rotation. Consistent with these univariate results, the
multivariate analysis in Pane l B finds the main effect for auditor rotation insignifican t
(p = .24).
Research question 2a asks whether earnings beliefs will be lower when the audit com-
mittee is strong compared to when it is relatively weak. As shown in Table 2 Panel A,
mean (median) estimated EPS is 1.081 (1.07) and 1.086 (1.09) under the strong and rela-
tively weak audit committee, respectively. As shown in Panel B, the main effect for audit
committee strength is significant (p = .02), indicating that a strong audit committee is per-
ceived to constrain earnings management to a greater extent than a relatively weak audit
committee. Research question 3a asks whether the effect of auditor rotation on earning
beliefs depends on a udit committee strength. Panel B shows that the interaction between
auditor rotation and audit committee strength is not significant (p = .83), indicating that

the effect of auditor rotation was not significantly different by level of audit committee
strength.
In the second analysis related to research questions 1b to 3b, the dependent variable is
the participant’s assessment of the auditor’s perceived independence. Descriptive stat istics
Table 3
Experiment 1 – Analysis of auditor rotation and audit committee strength on perceived independence
a
Panel A: Descriptive statistics
Audit committee strength Auditor rotation
Partner Firm Overall
Relatively weak NNN
Mean Mean Mean
(STD)(STD)(STD)
35 30 65
4.63 4.59 4.61
(1.52)(1.72)(1.60)
Strong 28 32 60
5.46 5.24 5.34
(1.13)(1.35)(1.24)
Overall 63 62 125
4.99 4.92 4.96
(1.41)(1.56)(1.48)
Panel B: GLM ANOVA – Perceived external auditor independence
Effect df F Prob. Research question
Auditor rotation 1 .24 .62 1b
Audit committee strength 1 8.12 .005 2b
Auditor rotation by audit committee strength 1 .12 .73 3b
Error 121
a
Participant beliefs about the independence of CAP’s external auditor, answered on a seven-point scale

anchored on 1 – low independence and 7 – high independence.
186 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
and statistical results are reported in Table 3, Panels A and B, respectively. As shown in
Panel A, mean perceived independence is 4.99 and 4.92 under the audit partner and audit
firm rotation, respectively. As shown in Panel B, the main effect for auditor rotation is
insignificant (p = .62) as is the interaction between auditor rotation and audit committee
strength (p = .73). Consistent with the earnings beliefs, the main effect for audit committee
strength is highly significant (p = .005), indicating that participants perceived auditor
independence to be higher when the audit committee was strong rather than relatively
weak.
4. Methodology and results for Experiment 2
The results reported above indica te that non-professional investors’ perceptions were
not associated with the form of auditor rotation. However, the case involved a relatively
short firm-client relationship of 5 years. Experiment 2 was conducted to provide evidence
related to a setting involving a long firm-client relationship of 26 years. Non-professional
investors might consider five years to be too short for au ditors’ independence and judg-
ment to be impaired. From a sociological perspective, moral seduction is based, in part,
on the notion that ‘‘long-term assignment to an audit increases the degree to which audi-
tors will view themselves as affiliated” (Nelson, 2006, 35) and a longer relationship may be
perceived detrimental to auditor independence even if no differences are found between
firm and partner rotation in a shorter period. From an economic perspective, in the part-
ner rotation condition the probability of future quasi rents may not be perceived as great
as in a longer relationship such that, again, a longer relationship may be perceived detri-
mental to auditor independence.
4.1. Methodology and experi mental task
Experiment 2 was a between-participants experiment that manipulated auditor rota-
tion at two levels. The experimental task was the same as described above for the initial
study, except that the client, CAP, had been a client of the audit firm for the past 25
years. Twenty-five years was selected as the period of association because we felt that
it clearly represented what would be regarded as a long-term relationship betw een the

audit firm and the client. The audit committee was characterized using the relatively
weak treatment from the initial study. The manipulation of aud itor rotation is similar
to that described in the initial study. Under the partner condition, the case indicated that
after this year’s audit, the current audit partner woul d rotate off the client and the audit
firm would assign a new audit partner for next year’s audit. Under the firm condition,
the case indicated that the audit committee had adopted a new policy on external audit
firm rotation, and that after this year’s audit (26th year) a new audit firm would be
selected to audit next year’s financial statements. The de pendent measures, additional
questions, and background questions were also the same as those used in the initial
study.
11
11
We did change the dependent measure for the most likely reported EPS to clarify that the audited financial
reports were with a ‘‘clean” audit opinion for the year.
S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 187
4.2. Prelimin ary results
Participants included 73 day and evening MBA students who were randomly assigned
to one of the two auditor rotation conditions and completed the experi ment in class with
one of the authors present. Fifty-five participants correctly answered the manipulation
question related to auditor rotat ion, indicating that participants generally read and inter-
preted the treatment variable as intended. Similar to experiment 1, those incorrectly
answering the manipulation question were dropped. In sensitivity analyses, not shown,
all participants were included and the results are substantially the same as reported.
Table 4 presents a profile of the 55 participants. Participants’ mean age was about 30
and their mean work experience was about 9 years. Participants’ demographic profile
and task attitudes are very similar to the participants of Experiment 1. There is no signif-
icant difference across auditor rotation conditions for any of the demographic or attitude
variables (p > .10) suggesting that randomization of participants to condition was
effective.
12

4.3. Analyses of auditor rotation research question
As in Experiment 1, the dependent variables are the participant’s earnings correction
belief and perceived independence. The independent variable, at two levels, is auditor rota-
tion (partner or firm). Panel A Table 5 presents descriptive statistics for the dependent
variables by auditor rotation condition and Panel B presents statistical results.
Research question 1a asks whether earnings correction beliefs will be larger when the
audit firm is rotated compared to when the audit partner is rotated. As shown in Panel
A Table 5, mean estimated EPS is 1.081 and 1.084 under the audit partner and audit firm
rotation, respectively. The analysis in Panel B reveals the difference to be insignificant
Table 4
Experiment 2 – Profile of 55 participants’ background and attitudes
Mean Std.
dev.
Minimum Maximum
Panel A: Profile of participants’ background
Age 30.98 6.65 24 52
Years of professional work experience 8.98 6.45 2 29
Gender (0, male or 1, female) .40 .49 0 1
Experience owning stock (0, no or 1, yes) .78 .42 0 1
Ability to understand financial reporting (1, very low to 7, very
high)
4.60 1.56 1 7
Panel B: Profile of participants’ task attitudes
Materiality of audit difference (1, not material at all to 7, highly
material)
5.60 1.21 3 7
Task realism (1, very unrealistic to 7, very realistic) 5.25 1.07 3 7
My assessment of the trustworthiness or reliability of the annual
audited financial statements strongly influences my investment
decision (1, strongly disagree to 7, strongly agree)

5.32 1.32 1 7
12
In sensitivity analyses, not shown, we also include each of the background variables as a control variable in
the models reported in the results. None of the variables are significant and the reported results are unaffected.
188 S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192
(p = .42), indicating audit firm rotation is not perceived to constrain earnings management
to a greater extent than audit partner rotation in a setting involving a long-term audit firm-
client relationship. Panel A also shows that mean perceived independence is 4.46 and 4.19
under the audit partner and audit firm rotation, respectively. The analysis in Panel C
shows that the difference is again not significant (p = .55), indicating audit firm rotation
is not perceived to strengthen perceptions about auditor independence in a setting involv-
ing a long-term audit firm–client relationship.
5. Summary
This research provides evidence on whether non-professional investors’ earnings beliefs
and independence percept ions differ between audit firm rotation and audit partner rota-
tion. The results from Experiment 1 indicate that across two levels of audit committee
strength, non-professional investors’ perceptions did not significantly differ between audit
partner rotation and audit firm rotation. Audit committee strength, however, significantly
influenced both perceptual measures. Our results for audit committee strength extend
Sharma’s (2006) finding that non-professional investors value corporate governance at
the overall board level by demonstrating that the audit committee, specifically charged
with monito ring financial reporting, is also valued by non-professional investors.
Table 5
Experiment 2 – Analysis of auditor rotation on most likely reported (audited) EPS
a
and perceived independence
b
Panel A: Descriptive statistics
Auditor rotation EPS
a

Independence
b
Partner NN
Mean Mean
(STD)(STD)
28 28
1.081 4.46
(.012)(1.67)
Firm 27 27
1.084 4.19
(.012)(1.80)
Overall 55 55
1.082 4.33
(.012)(1.72)
Panel B: GLM ANOVA – Most likely reported EPS
Effect df F Prob. Research question
Auditor rotation 1 .66 .42 1a
Error 53
Panel C: GLM ANOVA – Perceived external auditor independence
Effect df F Prob. Research question
Auditor rotation 1 .36 .55 1b
Error 53
a
Most likely reported (audited) EPS is either $1.07, $1.08, $1.09, or $1.10.
b
Participant beliefs about the independence of CAP’s external auditor, answered on a seven-point scale
anchored on 1 – low independence and 7 – high independence.
S.E. Kaplan, E.G. Mauldin / Journal of Accounting and Public Policy 27 (2008) 177–192 189
The results from Experiment 2 provide further evidence on whether audit firm rotation
offers perceptual benefits to non-professional investors. The setting for Experiment 2 was a

long audit firm-client relationship. Results from this experiment provide consistent results,
again indicating that perceptions did not significantly differ between audit firm rotation
and audit partner rotation.
This research is subject to limitations common to experimental projects. In particular,
as part of the experimental approach, participants responded to a hypothetical scenario
about the discove ry of an audit difference in which information is limited by design and
may not represent all the information that might normally be available and used by inves-
tors. Since public information about negotiations among top management, the audit com-
mittee, and the external auditor is scant, the case reflects this reality about current financial
reporting. In addition, this approach is becoming increasingly common within financial
accounting research (Libby et al., 2002) and an experiment is particularly well suited to
the current focus because it allows us to examine two perceptual measures, earnings beliefs
and perceived auditor independence. Although it is not possible for users to actually
observe negotiations of audit differences, the beliefs users form about how audit differences
are resolved are likely to ultimately affect the confidence users have in financial statements.
In addition, our study uses MBA students as proxies for non-professional investors.
For our task, low integrative and not an investment decision, Elliott et al. (2007) finds that
MBA students’ judgments are consistent with judgments of other non-professional inves-
tors. Still, it is possible that our participants are not representative of all non-professional
investors and our sample is not representative of more sophisticated investors, such as
institutional investors or financial analysts. Thus, our results may not generalize to more
sophisticated professionals (Frederickson and Miller, 2004).
Our research complements archival studies of the relation between audit firm tenure
and auditor independence in fact. While these studies provide important insights, archival
studies are limited in their ability to assess perceptual measures such as independence and
are not capable of providing evidence on the effect of a proposed change to audit firm rota-
tion policies. Using an experimental approach, our study was designed to provide percep-
tual evidence about a potential alternative to audit partner rotation policy. Our findings
on auditor independence in appearance extend archival research and supplement the
GAO’s (2003) finding that the current required audit partner rotation will sufficiently

achieve the benefits of a udit firm rotation for auditor independence in fact. While one
should be cautious about making inferences about the absence of an effect, the results
across two studies offer consistent evidence that audit firm rotation is perceived similarly
to audit partner rotation. This evidence should be useful to policymakers as they further
consider the need for mandated audit firm rotation. Finally, our research also contributes
to the corporate governance literature by demonstrating that stronger audit committees
are perceived by non-professional investors to constrain earnings management and to
enhance perceptions of auditor independence.
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