Effect of Auditor Rotation on Relationship Between Financial Manipulation and Auditor’s Opinion

Abstract

Background: Since external auditors possess expertise necessary for detecting manipulation in financial statements, they also have an obligation to take into account earnings management that could lead to it. In that context, auditor’s independence, which can be affected by auditor’s rotation, is of utmost importance.  Objectives: The aim of this paper was to examine the moderating effect of auditor rotation on the relationship between the extent of financial manipulation and type of auditor’s opinion for companies listed on Zagreb Stock Exchange in Republic of Croatia. Methods/Approach: Panel analysis with logistic regression was conducted to test research hypotheses. Sample consists of 210 observations during the three-year period from 2015 to 2017. Results: The results showed significant negative relationship between level of financial manipulation and tendency to issue positive audit opinion, as well as statistically insignificant positive moderating effect of auditor rotation frequency during the considered period on the relationship between financial manipulation and auditor’s opinion. Furthermore, there was a negative, but also statistically insignificant moderating effect of auditor rotation in current financial year on the relationship between financial manipulation and auditor’s opinion.  Conclusions: Absence of auditor rotation shouldn’t be considered as a red flag indicating reduced auditor’s independence.