Audit Firm Perspective on Audit Firm Rotation and Enhancing Independence: Evidence from PCAOB Comment Letters Free

This study synthesizes practitioners' perspectives on solutions to enhance independence in the auditor-client relationship as solicited by the Public Company Accounting Oversight Board (PCAOB 2011; hereafter, the Board) in its “Concept Release on Audit Firm Rotation and Auditor Independence” (the Concept Release). Using publicly available data from the PCAOB's website (specifically PCAOB Docket No. 37), we collect and summarize all comment letter responses submitted by American accounting firms to address two specific research questions.¹ One, what arguments are made to support practitioner opposition to audit firm rotation and, two, what do the firms appear to offer as the most salient solutions to enhance independence in the auditor-client relationship?

In August of 2011, the PCAOB issued the Concept Release to generate public opinion on efficient and effective vehicles for improvement in the independence relationship between auditor and client (PCAOB 2011). Through the release, the PCAOB requested comment on strengthening the independence relationship between auditor and client via specific questions related to audit firm rotation, as well as viable alternatives to audit firm rotation. Specifically, the general issue section of the release (outlined in Table 1) contains questions regarding enhancement to auditor independence, objectivity, and professional skepticism (general issue Question 1), feasibility of auditor rotation (general issue Questions 2 through 6), alternative solutions to mandatory audit rotation (general issue Question 7), and improvement to the PCAOB's inspection process (general issue Question 8). In addressing our research questions, the present study initially discusses practitioner rationale opposing audit firm rotation and then focuses primarily on alternative suggestions to improve independence—resulting in examination of firm comment letter responses to general issue Questions 2, 3, 5, 7, and 8.²

Altogether, this study summarizes the perspectives from 15 PCAOB-registered accounting firms on the Board's Concept Release. Of those 15 firms, eight are annually inspected by the PCAOB and seven are inspected tri-annually by the agency. Through their comment letters, each of these firms share their viewpoints on audit firm rotation but, most importantly, the firms also engage in proactive dialogue concerning alternative solutions to engender positive change in the auditor-client independence relationship. Of those alternative solutions to audit firm rotation, we find that the overwhelming majority of the comments are geared toward further empowering the audit committee, while a few solutions involve various suggestions aimed at firm quality control and regulation.

The study's primary contribution offers that practitioners overwhelming advocate for modification to the audit committee to augment auditor independence. This should be of interest to all those engaged in the auditor-client independence debate—regulators, academicians, practitioners, management, and investors. While regulators have traditionally attempted to strengthen independence by introducing regulation surrounding the external auditor, our review of audit firms' perspectives indicates that perhaps a shift in regulatory philosophy is warranted—one that includes addressing independence strength at the client level rather than primarily at the auditor level.

Over the last decade the Board has passed 18 audit standards and proposed numerous other rules, releases, and advices. Most of these rulings have created little buzz among auditors and issuers.³ However, one area of interest that serves as a continual catalyst for controversy is that of auditor independence. That said, regulators have generally shown interest in correcting the perception of maligned independence in the auditor-client relationship at the auditor level rather than the client level. For example, regulation surrounding the length of tenure of an auditor (at the firm, partner, and manager level) receives regular attention and discussion of revision. Also, services provided by an auditor to an audit client are often a target for criticism in the independence relationship debate. Although rare, augmenting the client's responsibilities in the relationship emerges as an alternative as well.

Perhaps the biggest outgrowth from the independence debate is the suggestion that accounting firms are mandated to rotate from audit engagements of publicly traded companies at some defined time period. The general consensus among U.S. corporations and audit firms is that audit firm rotation will lead to increased regulatory costs as well as lower-quality audits (Aubin 2013). The major benefit typically discussed in reference to auditor rotation is fairly ubiquitous: immediate improvement in independence between client and auditor. The argument made by pundits of rotation asserts that long-term client service relationships taint the ability of an independent auditor to remain skeptical, especially in those cases where the engagement is large and material to a firm's revenue base (Whitehouse 2013). However, many of those focused on silencing the rotation argument cite literature and empirical evidence that recognize little support for an inverse relationship between audit quality and auditor tenure. In fact, a plethora of studies find that audit quality is strengthened over time and is impaired at its fullest in the initial years of an engagement (e.g., Carcello and Nagy 2004; Ghosh and Moon 2005; Blouin, Grein, and Rountree 2007). Essentially, the anti-rotation argument rests on audit engagement infancy contributing to lack of exposure to the issuer-specific corporate model and an overall deficient understanding of core business practices, as well as a higher likelihood of undetected fraudulent reporting. Further, opponents submit that cost-benefits are disproportionate—typically citing a 2003 GAO report that suggests engagement costs balloon by upward of 20 percent in the initial year of an audit (McTague 2013).

Concerning regulators, the Sarbanes-Oxley Act of 2002 (U. S. House of Representatives 2002 [SOX; or, the Act]) dismissed the idea of mandating audit firm rotation in favor of other measures designed to combat independence issues between auditor and client. Primarily, the Act mandated that audit committees, independent of corporate management, take responsibility for all governance and continuance practice related to the external audit—including appointment of an auditor, approval of non-audit services, and determination of auditor compensation (Gupta, Weirich, and Turner 2013). SOX also hastened audit engagement partner rotation from seven years to five, while extending the mandatory partner cooling-off period to five years from the previous requirement of two. Most importantly, the Act established the PCAOB as the independent public company audit regulator.

Amid renewed interest in the auditor-client independence relationship spurred by the global financial crisis, the PCAOB (2011) again approached the subject of the auditor-client independence relationship when the agency issued its 2011 Concept Release. At the same time, peer regulatory authorities in other jurisdictions such as the European Union (EU) began to consider the idea of instituting audit firm rotation. In fact, the EU (2014) formally adopted mandatory audit firm rotation into law on May 27, 2014. Among other items, the legislation mandates a change in auditors after ten years of service for publicly traded entities (effective in June 2016). However, the tenure can be extended for upward of 24 years for those engaged in joint audits and upward of 20 years for those companies that engage in retendering the audit.⁴ Additionally, the regulation prohibits any contractual obligation in banking agreements that require a Big 4 audit—effective June of 2017 (EU 2014).

The PCAOB has suggested it will monitor audit firm rotation programs; however, the controversy/limitations of audit firm rotation in the United States may preclude the PCAOB from instituting such regulation. However, audit rotation programs may be established organically by public companies. For example, Apple Inc. has purposefully retendered its auditor every five years for decades (McTague 2013). Most recently, two prestigious organizations, the London Stock Exchange and Unilever, dropped long-time auditor PricewaterhouseCoopers (PwC) in a stated attempt to overhaul their audit relationships in a time of changing market expectations (Kleinman 2013).

While firm opinion on audit firm rotation is of interest, the crux of the current study lies with disseminating practitioners' perspectives regarding viable alternatives to enhance the auditor-client independence relationship. Previewing our results, we find that the American accounting firms believe that retooling and strengthening the client's audit committee is the overwhelming resolution to enhance independence. Beyond developing the base expectations of the auditor-audit committee relationship through SOX, regulators have since established little guidance for the audit committee. Further, at least superficially, it appears monitoring and updating the standards of Title III of the Act (related to corporate responsibility) have taken a backseat to improving the tenors of Title II (related to auditor responsibility). Taken at face value, the practitioner perspective on ameliorating independence concerns at the client level as opposed to the auditor level might seem disingenuous and self-serving. However, looking at the suggestions from a different angle, the firms appear to implore regulators to consider strengthening the entity charged with both monitoring their work and keeping management at bay. This introduces a shift in the current paradigm, whereby the client would be charged with accepting more responsibility and accountability in the independence relationship.

According to Königsgruber (2013), accounting professionals are viewed as one of the most active participant groups in lobbying their standard setters. Importantly, the PCAOB considers its public opinion forum an integral component in the development of the Board's public company audit guidance (PCAOB 2014b). To that end, as the PCAOB advances its regulation agenda, the agency actively solicits and receives public comment from a variety of constituent groups—many of which are professional accountants. Regarding the PCAOB's public forum, public accounting firms have a vested interest in the authoritative guidance promulgated by the agency because registered public accounting firms are the primary entities subject to the PCAOB's regulation.

The PCAOB uses an online document repository system to maintain individual files for each rulemaking document publicly released, as well as those constituent documents written in response to the rulemaking releases. The individual files are organized by “docket” number. The PCAOB maintains 40 dockets on its website, where Docket 37 contains all of the publicly available information related to the PCAOB's Concept Release explored in this study. We obtain the comment letters of all public accounting firms that submitted a response to the PCAOB's Concept Release, with relevant information outlined in Table 2.

We examine the comment letter perspectives of firms that meet two basic criteria as of the issuance of the Concept Release: (1) the firm is registered with the PCAOB, and (2) the firm retains at least one public company audit subject to PCAOB inspection.⁵ This eliminated six firms from the study found in Table 2: BeachFleischman PC; Cravath, Swaine & Moore LLP; Gorman & Associates P. C.; Packer Thomas; PKF International Limited; and Praxity AISBL. Of those accounting firms meeting the aforementioned criteria, the study includes the four largest global accounting firms (commonly referred to as the “Big 4”) Deloitte LLP, Ernst & Young LLP, KPMG LLP, and PwC LLP, as well as the next four largest global firms—BDO USA LLP, Crowe Horwath LLP, Grant Thornton LLP, and McGladrey & Pullen LLP. As depicted in Table 2, these eight firms are inspected annually by the PCAOB. The study also utilizes the comments of seven American regional firms—Battelle & Battelle LLP, BKD LLP, Eide Bailly LLP, EisnerAmper LLP, Piercy Bowler Taylor & Kern, UHY LLP, and WeiserMazars LLP. These seven firms are inspected by the PCAOB on a tri-annual basis.⁶

We parse firms' perspectives on audit firm rotation into several subcategories of firm type: Big 4 firm, non-Big 4 firm, regional firm, annually inspected firm, tri-annually inspected firm, and overall. As expected, none of the firms illustrate support for audit firm rotation, while 33 percent of overall firms show support for remedial rotation. Of note, we find that two of the Big 4 and three regional accounting firms support remedial rotation while all four non-Big 4 and two regional accounting firms do not show support for remedial rotation (four firms overall chose not to address this topic).⁷ Through further examination of the comment letters, we find several common themes among the 15 firms for both their rationale against audit firm rotation, as well as their insight into potential adverse effects caused by audit firm rotation. We explore the more salient commonalities found in the comment letters in an effort to gauge agreement among the audit firms. Table 3 summarizes these findings.

First, we note that 100 percent of the firms suggest that no evidence exists to indicate that prolonged audit firm tenure is related to diminished audit quality, where many of the firms cite academic literature to support their argument. Further, before considering additional authoritative guidance on audit firm rotation, KPMG (2011) suggests that the PCAOB's engagement quality review and risk assessment standards, as well as its staff practice alerts, have been heavily lauded by the Board and should be given sufficient time to assess their effect on independence. Accordingly, we note that 88 percent of the annually inspected firms (one of eight chose not to address this topic) and 71 percent of the tri-annually inspected firms (five of seven, where two chose not to address) offer that the PCAOB should allow time for the current standards to materialize.

Of particular interest, firms such as BKD (2011) and McGladrey & Pullen (2011) contend that specialized industry expertise within certain geographic regions as well as specific industries does not exist interchangeably among the firms. In fact, an analysis performed on audit specialization notes that of the 500 largest public companies only two or three audit firms have a significant client base in certain industries (Deloitte 2011). Combing the letters, we note that 80 percent of all firms (100 percent of the annually inspected firms and 57 percent of the tri-annually inspected firms) believe that the requisite specialized knowledge needed to perform audits interchangeably across industries does not exist. Broken down further, eight of the 11 non-Big 4 firms (the other three chose not to address this topic) agree that audit specialization does not exist at a level sufficient to support audit firm rotation. Considering non-Big 4 firms conceivably have the most to gain regarding an increase in their client bases, advocating against audit firm rotation by admitting that certain expertise does not exist beyond the Big 4 is particularly interesting.

Firms believe that the PCAOB's oversight of the profession has enhanced audit quality, where KPMG (2011) suggests that the inspection program incentivizes auditor independence by providing audit teams with the possibility that “fresh eyes” might review the work. Further, Ernst & Young (2011) submit that the inspection process has made a profound effect on the firm's audit practice—a summary of annual inspection findings is distributed to all audit teams in an effort to facilitate professional awareness and discussion of significant auditing concerns. We find that 93 percent of the firms indicate that the PCAOB's inspection process is one of the main contributors to increases in audit quality (one regional firm chose not to address this topic).

As noted in Table 3, 100 percent of the firms suggest that increased costs stemming from rotation would outweigh the benefits of rotation. Stated best, firms generally indicate that audit firm rotation has been examined several times in the U.S. and does not pass the cost-benefit test, where the primary concern is not direct engagement costs but the costs of diminished audit quality and impaired reliability of financial reporting (PwC 2011). Further, beyond jeopardizing audit quality, Crowe Horwath (2011) argues that audit firm rotation would introduce significant new engagement risks, as well as create unintended consequences deleterious to the audit function. In fact, 93 percent of firms (100 percent of the annually inspected firms and 86 percent of the tri-annually inspected firms) agree that diminished audit quality would occur as a result of rotation (the remaining firm chose not to address this topic), while all Big 4 firms advocate that diminished financial reporting quality would also likely occur (where 10 of 11 non-Big 4 firms chose not to address this topic).

According to Ernst & Young (2011), employing audit firm rotation would also be cumbersome from a staff retention perspective, where rotation among entire teams of auditors might cause professionals to seek other careers to avoid excessive travel or relocation. Continuous turnover of clients could also inflate firms' direct costs through incessant recruiting expenses, relocation of personnel, and severance payments (BDO 2011). Comment letters point out that 73 percent of firms contend that a disruption in the workforce would occur due to continuous attrition of the firm's client portfolio.

Perhaps the most condemning argument against audit firm rotation suggested by the firms is that the practice would undermine the spirit of SOX and lead to deterioration of corporate governance (Crowe Horwath 2011). As pointed out by Grant Thornton (2011), SOX empowered the audit committee to appoint the auditor, approve all services, and oversee the entire audit function. Audit firm rotation would dismiss the relevance of the committee's role and could cause unintended consequences such as inadequate monitoring of the audit firm, as well as diminished interaction with independent directors. We note that nine of 15 firms (67 percent) cite that rotation would cause audit committees to lose their effectiveness (all other firms chose not to address this topic); simultaneously, we also find that the overwhelming majority of firm alternative solutions to rotation lie with improving the auditor-client relationship at the client level. As noted in the following section, the firm comment letters examined in this study advocate for wholesale upgrades to the audit committee in an effort to enhance the monitoring component of the independence relationship. Strengthening the audit committee as opposed to the external auditor creates a paradigm shift in thought regarding regulatory philosophy.

On February 5, 2014, during a budgetary meeting between the SEC and the PCAOB, Chairman James Doty intimated that the PCAOB would no longer pursue audit firm rotation—effectively refocusing the independence agenda going forward for the PCAOB (Chasan 2014). At least in the short term, this indicates that the PCAOB will shift its efforts in improving independence and professional skepticism. In fact, the PCAOB currently lists “Auditor Independence, Objectivity, and Professional Skepticism” on its June 30, 2014 Office of the Chief Auditor (OCA) Standard-Setting Agenda (PCAOB 2014a). Here, the topic is listed under “Other Active Projects” with a status of “Next steps under consideration” (PCAOB 2014a). Of note, the December 31, 2013 version of the standard-setting agenda listed the project as “Auditor Independence and Audit Firm Rotation.”

After considering the firms' perspectives on audit firm rotation, we examine the individual firm comment letters submitted in response to the PCAOB's Concept Release for alternative suggestions to enhance independence. As previously noted, 67 percent of the firms (88 percent of annually inspected firms and 43 percent of tri-annually inspected firms) indicated that audit firm rotation would cause a diminished effect on the audit committee. In fact, firms suggest that audit firm rotation would undermine the committee's responsibility—an original tenet of the Act. According to the firms, a significant focus of the independence discussion should be centered on improvement to audit committee effectiveness.⁸

The extant academic research supports this sentiment. Following Francis (2004), multiple studies present evidence that audit quality is directly impacted by the independence attribute of an audit committee. Here, the author relays that audit committees demonstrating robust independence are attributed with a higher likelihood of auditors issuing going concern opinions as well as maintaining a lower likelihood of firing an audit firm post-issuance of a going concern opinion. Further, among audit committees displaying strong independence traits, abnormal accruals (earnings management) are less persistent, while external auditors are noted to have a higher likelihood of detecting accounting irregularities.

Through their comment letters to the PCAOB, the firms propose that strengthening various artifacts of the audit committee would have an important effect on the auditor-client independence relationship, advocating that commitment to its strengthening should be a primary objective of the independence debate. This study summarizes firms' perspectives on improving the effectiveness of the audit committee while briefly echoing practitioners' opinions on other suggestions regarding improvement to the auditor-client relationship.

For the audit function to operate efficiently and effectively, it must be overseen in the same manner. Accordingly, an integral component of the financial reporting process is the development of strongly independent and influential audit committees. Implementing new methods for strengthening the effectiveness of audit committees would benefit stakeholders in that it would provide a vehicle for enhancing independence and, as a result, audit quality would improve (BKD 2011). In turn, the effectiveness of the audit committee, a fundamental precept in the management of an issuer's audit quality, would have an important impact on an issuer's financial reporting (Deloitte 2011). In the following three sections, we note the practitioner perspective on improving the audit committee (see Table 4) through strengthening components surrounding its overall function, communication, and regulation.

Related to the comments taken directly from audit firms, practitioners actually request that audit committees act independent of management and serve as effective counterbalances to management pressure straining the auditor-client independence relationship (Ernst & Young 2011). Strictly regarding the continuance process, practitioners submit to the PCAOB that the direct reporting relationship between firm and audit committee needs greater emphasis by suggesting that the audit committee play the most prominent client-side role in continuance. Firms recommend that audit committees meet with potential candidate firms without the pre-approval of management and add that the committees should provide guidance on fee negotiation (Deloitte 2011). Directly related to the Act, audit firms appeal to the PCAOB, as well as the SEC, to ensure that audit committees possess, in both fact and appearance, sole responsibility over the continuance process. In fact, although implicit, practitioner comment letters appear to advocate that the original SOX requirements surrounding continuance are nothing more than a straw man.

Concerning best practices and training, firms consider assessing the quality of work performed by external auditors as the key factor in oversight of the audit function (Ernst & Young 2011). These practitioners also promote the use of client-led audit firm rotation as well as construction of joint audit teams as deemed necessary by the audit committee (McGladrey & Pullen 2011; WeiserMazars 2011). To that end, firms advocate that audit committees require at least one member of the audit committee possess the requisite skills as an auditing expert or well-rounded financial expert (Deloitte 2011; Ernst & Young 2011; BDO 2011). Further, firms believe that public companies should develop audit committee roundtables for the dissemination of practices designed to best effectuate robust independence relationships.

Overall, as suggested by Eide Bailly (2011), academic research asserts that there is a linear relationship between audit quality and informed, diligent audit committees. Noted throughout the literature, audit quality is directly influenced by the auditor-client independence relationship. To the extent that audit committees take ownership of the audit function and continuance processes, independence will improve, and as a result audit quality will increase.

Also of paramount importance to the audit function, the basis for building trust in a relationship among audit engagement stakeholders is the level of communication and disclosure of value-relevant, salient information (WeiserMazars 2011). The firms note that increased communication between audit firms, audit committees, and shareholders is vital to improving the independence and transparency of the audit (McGladrey & Pullen 2011; Ernst & Young 2011). Therein, practitioners suggest audit committees provide firms with an annual agenda of deliverables as well as timely formal evaluations and job satisfaction feedback. Further, firms submit that audit committees should thoroughly review the audit plan and request that their respective auditors provide increased effort around particularly risky areas of the audit. Firms even invite audit committees to inquire about findings from PCAOB inspections, as well as firm quality control inspections, to facilitate a desired comfort level (Ernst & Young 2011). Overall, ensuring that thoughtful, timely discussion between the audit committee and the auditor is undertaken on a regular basis will engender a stronger independence relationship, which in turn will foster a more robust audit function (Deloitte 2011; KPMG 2011).

Addressing the majority of the communication comments at the auditor level, the PCAOB issued Auditing Standard No. 16 (AS No. 16, PCAOB 2012a), “Communications with Audit Committees; Related Amendments to PCAOB Standards; and Transitional Amendments to AU Section 380” in August 2012. Table 5 shows that six of the seven auditor-audit committee communication suggestions noted in this study were mandated by AS No. 16. Of note, the PCAOB did not elect to require the auditor to discuss firm PCAOB inspection results with audit committees. The regulator justifies this by stating that the Act limits the Board's authority to force public disclosure of nonpublic inspection information. However, the agency did state that the Act does not restrict audit firms from disclosing inspection findings (including firm remediation and deficiencies in quality control) on their own volition to audit committees (PCAOB 2012a).

Where communication is concerned, the PCAOB states, “An audit committee that is well-informed about accounting and disclosure matters relating to the audit may be better able to carry out its role of overseeing the financial reporting process” (PCAOB 2010). That said, as the PCAOB has adopted communication requirements for the external auditor through AS No. 16, to yield a more robust independence relationship, it is important for regulators to consider other mandatory communication involving the audit committee to investors as well as auditors.

Firm comment letters offer suggestions for improving audit committee effectiveness through action from both key regulators present in the audit function—the PCAOB and the SEC (see Table 6). Concerning the PCAOB, practitioners believe that the agency should implement a judgment framework for evaluating the reasonableness of management's estimates in concert with developing training materials for audit committee oversight of the audit function (Deloitte 2011; Ernst & Young 2011). Firms emphatically note that audit committees should have access to direct interaction with PCAOB staff. Suggestions include the lead PCAOB staffer meeting with the audit committee chair prior to inspection, the PCAOB directly communicating inspection findings to the audit committee, and engaging with audit committees on matters of audit policy regardless of inspection status (Battelle & Battelle 2011; Deloitte 2011; Ernst & Young 2011; KPMG 2011; PwC 2011). Integral to the discussion, Deloitte (2011) offers that academic studies on audit committee performance post-SOX suggest that the robustness of an audit committee is a primary contributor to audit quality—the PCAOB could directly effectuate change by implementing the aforementioned requests.

Firms also submit that the SEC should define an expanded scope for the audit committee report that includes disclosing the audit committee's role and relative performance, as well as discussing the committee's assessment of the incumbent auditor's audit quality coupled with considerations in selecting a successor auditor (BDO 2011; KPMG 2011; McGladrey & Pullen 2011). This would allow audit committees to better inform investors whether and to what extent their interests are adequately represented by the independent committee charged with oversight of the audit function.

Altogether, utilizing the wealth of accumulated knowledge spurred by SOX to create audit committee guidance, which yields high-level external audit performance, is perhaps the backbone of remediating perceived problems with the strained independence relationship between auditor and client. By equipping audit committees with the tools to properly govern the audit process, regulators, including the PCAOB and SEC, can directly strengthen the independence relationship felt between auditor and client.

In order to enhance independence, auditors must develop a sense of urgency in self-improvement. As such, those charged with assurance must become more adept at instituting policies and procedures to improve the entire audit industry. To that end, audit firms should also endeavor to find ways to strengthen their internal quality control systems (BDO 2011). Concerning training, as suggested by BKD (2011), consideration should be given to mandating annual training on independence and professional skepticism in order to bolster their perceived relevance in effective assurance practice and to tie them to objectivity and auditor judgment.

Aside from training, another way of improving firm quality control, as suggested by Deloitte (2011), might lie with the creation of firm audit quality advisory councils. Comprised of independent external advisers, these councils would be a radical step in delivering an unbiased perspective on firm audit quality as well as assessing firm problems with independence, objectivity, and professional skepticism. Perhaps controversial, PwC (2011) suggests that accounting firms that serve as the financial statement auditor of more than 100 issuers publish an annual report detailing the firm's commitment to internal quality control. Here, the report would also reveal important inner workings of the firm such as the audit partner compensation model and firm governance structure. Stated best, adherence to firm quality control standards created through proactive interaction with the regulators will most likely relate directly to ameliorating uncertainties surrounding the auditor-client independence relationship (KPMG 2011).

The firms further responded to the PCAOB's request by illustrating a critical belief in enhancement to independence via the regulatory agenda. Among the areas of needed improvement, the firms suggest that the most beneficial would be enhancements to the standards and framework process, as well as inspection practices and development of PCAOB-led training. For example, PwC (2011) encourages the PCAOB to move forward with proposals to adopt certain changes to the standard auditor report—where proposed standards currently aim to incorporate the disclosure of explicit statements regarding firm independence, firm tenure, areas of complex auditor judgment, partner identity, and other external audit firm participation. The Board believes these disclosures will help spur a deeper level of comfort surrounding the external auditor for investors.

Concerning improvement to the inspection process at the PCAOB, firms note that the regulator should focus on identifying the root cause of deficiencies at the firm level, rather than engagement-specific deficiencies, and address the length of time that inspection teams take to draft and issue inspection reports (Eide Bailly 2011). Further, in an effort to be proactive during financial statement audits, firms believe that the PCAOB should adopt a practice similar to the consultation services provided by the SEC (Deloitte 2011). To further elaborate on the SEC practice, if uncertainty surrounding the application of GAAP is experienced by auditors, then audit committees, or management, then the SEC suggests consultation with the Commission's accounting staff.⁹ Firms imply that similar guidance from the PCAOB would be most salient for an auditor in a pre-opinion scenario and would improve the audit function. However, the SEC staff also encourages consultation with the Office of the Chief Accountant (OCA) on auditing concerns as well, especially those that involve complicated transactions and concerns with auditor independence (SEC 2001). Therefore, while the PCAOB might not currently offer pre-opinion consultation on auditing or independence concerns, it appears that public accounting firms have an appropriate outlet to discuss concerns. Nonetheless, the firms' suggestion might encourage the SEC to prod the PCAOB into implementing a policy of consulting with audit firms on a pre-opinion basis. In fact, a form of pre-opinion consultation could help eradicate regulator concerns over independence that are currently only noted by the PCAOB in a post-audit inspection.

The PCAOB has hosted several open forums on the subject of auditor independence and audit firm rotation. In these meetings, some support was voiced for audit firm rotation (e.g., members of the PCAOB's standing advisory group), but the arguments against instituting rotation were clear—requisite domain-specific knowledge cannot be effectively gained over a period of a few years and will result in a reduction of audit quality. David Hirschmann, president and CEO of the U.S. Chamber of Commerce, Center for Capital Markets Competitiveness, says, “we support strong audit committee communications and auditor independence, but it is a hallmark of the American corporate structure … that directors and shareholders must be allowed to govern the corporation and that one size fit all mandates do not work” (Hirschmann 2012). In fact, William A. Osborn, audit committee chairman of Caterpillar Inc., asserts that rotation would undermine the audit committee's ability to govern in the best interest of shareholders, and further notes that he is confident in his committee's obligation to oversee that the auditor is professionally skeptical, objective, and independent (Osborn, Dickinson, and Greene 2011). The Board notes that most constituents favor the PCAOB considering less drastic alternatives such as mandatory retendering, more-targeted PCAOB inspections, audit-only accounting firms, joint audits, enhancing auditor training, and strengthening audit committees (PCAOB 2012b). Similar to the firms' viewpoints discussed in this paper, a host of alternative perspectives from audit committee chairs, chief accounting officers, academics, and portfolio managers also emphasize that the strength of the audit committee is the crucial element to facilitate more robust auditor-client independence.

In her October 8, 2012 public meeting statement, Michelle Edkins, managing director of Black Rock, focuses mostly all of her comments on the shareholder's perspective of boosting the utility of the audit committee. Most interesting, she suggests that her organization expects directors to be committed to training on technical issues, networking with others on best practices, and developing an understanding of cognitive biases, framing, and group dynamics related to decision making (Edkins 2012). The chief accounting officer of Northrop Grumman Corporation, Stephen E. Frank, suggests that the PCAOB better serve issuers by providing more timely results and reviews of the company's auditor directly to the audit committee. Further, he also mentions that the committee would benefit from the Board proactively communicating emerging issues and concerns from their inspections directly to audit committees (Frank and Heintz 2011). Similarly, the audit committee of Morgan Stanley opines that, where appropriate, the PCAOB should meet with audit committees to advise on concerns that the agency has about particular audit-client relationships (Nicolaisen, Davies, Hance, and Sexton 2011).

The chief objective of this study is to circulate the audit firm perspective on enhancement to the auditor-client independence relationship, as well as note practitioners' opinions on the pitfalls of implementing audit firm rotation. We find that the firms generally offer homogenous rationale for opposition to audit firm rotation; however, most importantly, we note that the overwhelming majority of the solutions offered to enhance independence lies with significant upgrades to audit committee effectiveness. That said, while regulators have generally been compelled to enhance independence by introducing regulation at the auditor level, our review indicates that perhaps a shift in regulatory philosophy is warranted. Accordingly, our study provides a succinct reference for those interested in exploring enhancement to independence through client-level improvement (principally through the audit committee) as opposed to improvement at the auditor level.

Audit deficiencies noted by the PCAOB inspection process have largely been referenced by the Board as the impetus to develop new audit regulation concerning independence and professional skepticism.¹⁰ Notably, inspection teams cite that deficiencies in audit work are often related to impairment in the independence of the auditor as well as failure to display appropriate professional skepticism.

It is important to note that while the PCAOB has continued to find problems in inspected audits at the largest accounting firms in the country, the firms acknowledge this and provide a wealth of ideas to correct those problems in their comment letters to the PCAOB's Docket No. 37. In fact, in their alternative solutions to audit firm rotation, the firms list a variety of vehicles that can be used to help combat the aforementioned specific deficiencies at all levels of the audit. While suggestions surrounding the audit committee are the primary focus, improvements concerning the auditor and regulator are also articulated.

After the PCAOB has conducted an audit inspection, the firm has 12 months to demonstrate to the PCAOB that it has remediated all documented criticisms of the firm's quality control system. Upon examination of the remediation, the PCAOB determines whether the firm adequately complied; if not, then the inspections division issues a quality control criticism letter to the public reprimanding the firm. Of note, only two annually inspected firms have received a quality control criticism letter from the PCAOB for failure to remediate identified audit deficiencies since the 2011 inspection period (PCAOB 2015).¹¹

Proactive communication in the PCAOB's public forum from audit firms, corporations, academics, professional associations, peer regulators, and individuals can significantly influence regulators in the evolution of audit guidance. Specifically, this study was contrived to collect and summarize practitioners' opinions on enhancing independence in an effort to facilitate improvement of the audit function. As the primary perspectives considered were those from professional accounting firms, we note that this has limited the contribution of our study. However, we also believe that it is a chance for future researchers to disseminate the collective thoughts of all commenters on PCAOB Docket No. 37, as well as other PCAOB forums documenting events and meetings on independence.¹² Along the same lines, further research is needed to document whether and to what extent the PCAOB uses constituent preference to effectuate change in its authoritative guidance. This line of research would effectively qualify the usefulness of the PCAOB's public forum with respect to how it shapes the Board's regulatory agenda.

As for future research ideas prompted by the findings of this study, we would like to see future research aimed at testing both firm rationale against audit firm rotation, as well as the alleged effects of audit firm rotation. First, have the aforementioned standards had enough time to materialize? Further, to what extent does audit firm specialization exist to supply the market with external auditors of interchangeable knowledge, how could this problem be ameliorated, and would implementing a joint audit process aid in increasing the ability to provide high-quality specialized knowledge? Researchers should also endeavor to answer questions regarding the suggestion that the PCAOB inspection process has improved audit quality as well as financial reporting quality. Going forward, as public companies registered in the EU employ audit firm rotation, future research streams might also consider quantification of increased audit costs regarding audit firm rotation as well as the effects of audit firm rotation on audit quality, financial reporting quality, and audit committee quality. Perhaps most interesting, a behavioral study related to the aforementioned adverse workforce effect would be beneficial in assessing how practitioners would react personally to audit firm rotation.

Regarding the role audit committees, auditors, and regulators play in the auditor-client independence relationship, future research could be tailored to answer the firm perspective on audit committee effectiveness, firm quality control, and regulation. For example, exploratory studies addressing simple questions surrounding the concentration of experts on audit committees, public companies that institute their own form of audit firm rotation, and quantifying audit committee level of independence from management would be particularly enlightening for regulators. In addition, an experiment conducted on the perception of audit committee expertise and resourcefulness might shed light on how investors feel about independence and professional skepticism surrounding the governance of the financial statement audit. Further, would direct interaction with the PCAOB heighten the audit committee's feeling of responsibility regarding the audit function? Concerning firm-level suggestions, would ideas such as firm advisory councils and publicly available firm quality control reports effectuate a change in mindset for the firms regarding independence? It would also be interesting to examine whether pre-opinion consultation with the PCAOB results in a reduction of inspection and remediation findings and costs. Finally, future researchers should endeavor to actually speak with (and interview) audit firm representatives regarding their views on how to improve independence and professional skepticism. This would bring richness and detail to the discussion.