Abstract

The three－year mandatory auditor retention requirement, which does not allow the firms to change their external auditors for three years, has been in effect since 1997 under the Act on External Audit of Stock Companies in Korea. This study examines whether this law improves the auditors' independence by analyzing the level of earnings management. We construct two groups：the change group, in which the firms switched their external auditors after their three－year audit contract period, and the control group, in which the firms did not change their external auditors after their three－year audit contract period. We compare and analyze any significant differences in the extent of earnings management for the two groups over their three－year contract period. Our sample includes 282 observations at the firm level over the period from 2002 to 2005. When auditors cause a conflict of interest against the firms through their strict or conservative auditing procedures, it is highly probable that the firms will switch their external auditor after the three－year mandatory auditor retention period. The empirical result supports our prediction. Our cross－sectional analysis shows that for the first－year in their contract period, the levels of earnings management for the change group are significantly higher than those for the control group while there is no significant difference between two groups for the second－and third－year in their contract period. In addition, our sub sample analysis demonstrates that the levels of earnings management during the first－year contract period are significantly higher than those during the second－and third－year contract period for the change group while there is no significant difference between the first－year contract period and the second－and third－year contract period for the control group. Therefore, our empirical results suggest that when the external auditors conduct their strict audit procedures they are still susceptible to the dismissal by the firms after their mandatory three－year audit contract period.

Keywords

• auditor retention
• earnings management
• discretionary accruals
• auditor change

Related Articles

• A Study on the Relationship between Auditor Tenure and Audit Quality

  CHOI， KWAN , Jong-Il Park

  13(3) 315-356

  Abstract Full Text for PDF

• Auditor Changes and Discretionary Accruals

  Kim Seon Mi , Yoo, Seung-Weon

  11(3) 95-122

  Abstract Full Text for PDF

• The Effect of Accrual-based and Real Earnings Management by Non-listed Small Firms on Auditor Choices －Focused on Initial External Audited Firms－

  Jong-Il Park

  14(3) 29-72

  Abstract Full Text for PDF

• The Effect of Timing of Auditor Change on Audit Quality

  Joon-Hwa Rho

  7(3) 29-51

  Abstract Full Text for PDF

• Audit Quality of External Audits and Internal Audits in Industry－academia Cooperation Foundation

  kim kyungmin , CHOI, JEONGUN

  23(6) 205-226

  Abstract Full Text for PDF