The mandatory audit partner rotation policy and cost of debt

Abstract

We examine the effect of mandatory audit partner rotation (MAPR) on the ex-ante cost of debt in the Chinese bond market. We find that the ex-ante annual bond yield spread significantly decreases in the year immediately after MAPR. This finding suggests that bond market investors value the net benefits of the MAPR policy and recognize the fresh-eyes effect of the new audit partner. Additional path analysis suggests that audit quality and market-based information asymmetry are significant channels through which MAPR reduces the ex-ante cost of debt. In addition, the effect is more pronounced for clients audited by Big 6 audit firms than by non-Big 6 auditors, and for clients with new audit partners who possess greater industry expertise than with less experienced audit partners. This indicates the role played by audit firms in reducing rotation costs and ensuring continuity in audit work. All of the findings hold after a set of robustness tests. Overall, the results provide empirical evidence demonstrating investors’ positive attitudes toward the MAPR policy.