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Managerial Auditing JournalThe effects of auditor rotation on client management's negotiation strategies

Regan N. Schmidt Britney E. CrossArticle in format ion:

To cite this document:Regan N. Schmidt Britney E. Cross , (2014),"The effects of auditor rotation on client management'snegotiation strategies", Managerial Auditing Journal, Vol. 29 Iss 2 pp. 110 - 130Permanent link to this document:http://dx.doi.org/10.1108/MAJ-03-2013-0836

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The effects of auditor rotationon client managements

negotiation strategiesRegan N. Schmidt and Britney E. Cross

Edwards School of Business, University of Saskatchewan, Saskatoon, Canada

Abstract

Purpose The purpose of this paper is to examine how audit partner rotation impacts thenegotiation strategies client management intends to use to resolve a financial reporting issue.

Design/methodology/approach An experiment that manipulates between participants onwhether the audit partner rotates from the prior fiscal year (rotation versus non-rotation) is conductedto test the theoretical implications of rapport. Participants with a high level of business and

managerial experience indicate their intended use of 25 reliable negotiation tactics that clientmanagement may use to resolve a financial reporting issue with the external auditor. These tacticsunderlie three distributive (contending, compromising, conceding) and two integrative (problemsolving, expanding the agenda) negotiation strategies.

Findings The results of the study indicate that client management is less contentious and moreconcessionary (i.e. accommodating) to a newly rotated audit partner, as compared to an audit partnerthat has established rapport with client management. Further, client management is more willing tointend using integrative and compromising (i.e. co-operative) negotiation strategies when negotiatingwith an audit partner with established rapport in contrast to a newly rotated audit partner.

Research limitations/implications These findings underscore the merits and costs of auditpartner rotation in auditor-client management (ACM) negotiations and document that partner rotationaffects not only auditor behaviour, but also the behaviour of client management.

Originality/value This paper is the first that considers how developing and maintaining rapport

impacts ACM negotiations. The study provides empirical evidence to further inform debates overauditor rotation.

KeywordsNegotiation, Rapport, Auditor, Client management, Rotation

Paper typeResearch paper

IntroductionA recent pronouncement from the European Commission to reform the European auditmarket, including mandatory audit firm rotation, has reopened debate on the meritsand costs of auditor rotation (European Commission, 2011). Repeat audit engagements

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/0268-6902.htm

JEL classification M42

The authors thank Lily Zheng Brooks, Richard Hatfield, Fred Phillips, Joseph Schmidt, andGanesh Vaidyanathan for their detailed comments and workshop participants at the Universityof Saskatchewan accounting workshop and the 2013 Canadian Academic AccountingAssociation Annual Conference. The authors thank the editors and anonymous reviewers fortheir helpful suggestions and constructive comments. The support of Nola Buhr andMark Klassen is gratefully appreciated. The authors acknowledge the financial support from theEdwards School of Business Centre for Advancement of Accounting Education. This paper isbased on the University of Saskatchewan undergraduate accounting honours research projectcompleted by Britney E. Cross, under the supervision of Regan N. Schmidt.

Managerial Auditing JournalVol. 29 No. 2, 2014pp. 110-130q Emerald Group Publishing Limited0268-6902DOI 10.1108/MAJ-03-2013-0836

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provide the auditor with the opportunity to accumulate knowledge of the clientsfinancial reporting practices and internal controls over financial reporting. Thoughincreased client-specific experience is crucial to audit quality (Carcello et al., 1992;

Johnson et al., 2002), standard setters have struggled to determine when auditor

familiarity with the client may threaten the external auditors independence(Dopuchet al., 2001). In response to these concerns in the American financial market,the Sarbanes-Oxley Act of 2002 Section 203requires engagement audit partners to rotateevery five years to strengthen external auditor independence (US House ofRepresentatives, 2002). Although prior archival research has documented the effectsof auditor rotation on overall audit quality (Carey and Simnett, 2006) and earningsquality (Chen et al., 2008), there is sparse empirical evidence examining the effect ofauditor rotation on specific audit tasks. This paper examines one such audit task,auditor-client management (ACM) negotiations, and specifically examines how clientmanagement negotiation strategies over financial reporting issues are affected by auditpartner rotation.

Negotiations between client management and the auditor to resolve financialreporting issues occur within a context that is influenced by interpersonal interactions.Gibbins et al. (2001) identifies that one particular element of these interpersonalinteractions is the audit partners past relationship with the client (Beattie et al., 2004).Hence, from an ACM negotiation model perspective, rotation of audit partners has animpact on the process and potential outcome of the negotiation (i.e. audited financialstatements). Hatfieldet al.(2011) was the first to examine the effects of auditor rotationon the auditors negotiation strategies; however, no research has examined howrotation impacts client managements negotiation strategies. Focusing on the otherside of the dyad is important, as one partys actions in a negotiation influence the otherpartys response (Bame-Aldred and Kida, 2007; Sanchez et al., 2007; Hatfield et al., 2008;Gibbins et al., 2005, 2007). In the context of mandated audit partner rotation, client

management is forced to develop rapport with the newly rotated audit partner incontrast to when rapport has already been established with the previous non-rotatedaudit partner. Rapport has theoretical implications for the types of negotiationstrategies used in conflict resolution (Tickle-Degnen and Rosenthal, 1990).

To examine how developing rapport and established rapport impacts clientmanagements intended negotiation strategies, we conduct an experiment thatmanipulates whether the engagement audit partner is newly rotated to the engagementor whether the engagement audit partner is the same as the prior year. The theoreticalimplications of rapport are then examined by measuring the participants intended useof 25 negotiation tactics that represent three distributive negotiation strategies and twointegrative negotiation strategies. These tactics are adapted from prior research(McCrackenet al., 2011) to the client management negotiation context.

Whereas distributive strategies focus on dividing a fixed pie of resources(i.e. win-lose), integrative strategies focus on expanding the pie of resources(i.e. win-win) and typically results in higher joint outcomes (Bazerman et al., 1985).Focusing on the intended use of distributive negotiation strategies, consistent with thetheory of rapport development, the results demonstrate client management intends to berelatively accommodating to the newly rotated audit partner, as evidenced by intendingto use less contending and more concessionary strategies. Stated differently, clientmanagement intends to be more contentious and less concessionary to the audit partner

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with which they have established rapport (i.e. the non-rotated audit partner), ascompared to the newly rotated audit partner. In regard to the intended usage ofintegrative negotiation strategies, the results document that client management intendsto use integrative strategies to a greater extent with audit partners with which rapport

has been previously established (i.e. the non-rotated audit partner) as compared to thenewly rotated audit partners, providing further support for the theory. That is,established rapport facilitates co-operation (rather than accommodation) to resolve thefinancial reporting issue.

This study provides further empirical evidence on the costs and merits of auditorrotation in one specific audit task ACM negotiations. The distributive strategyresults underscore the merits of audit partner rotation, whereby client management ismore willing to concede and less willing to contend with the newly rotated auditpartner. However, the results for the intended usage of integrative strategies call forfuture research to examine whether the benefits of increased intended usage ofintegrative strategies with non-rotated audit partners outweigh the costs of notrotating partners (i.e. familiarity threats).

The paper proceeds as follows. The next section reviews relevant research andoutlines our research hypotheses and research question. The following section containsthe experimental method, including the experimental setting and design. Our resultsare presented in the subsequent section followed by a discussion of the conclusions,limitations, and future research.

Background and hypothesis developmentThe ACM negotiation model developed by Gibbins et al. (2001) underscoresinterpersonal context as a category of contextual features that impacts the financialreporting issue resolution process. After inherent risk, the audit partners pastrelationship with the client was rated as the highest in importance among the

interpersonal contextual variables proposed in their model. Corroborating thesefindings, Beattie et al.s (2000) descriptive research documented the high level ofinteractive relations between client-management and the auditor when resolvingfinancial reporting issues and called for further research focused on the interpersonalrelationship (Beattie et al., 2001; Salterio, 2012 continues to call for future researchin this area). Accordingly, Beattie et al.s (2004) grounded theory model of ACMnegotiations documented that the quality of the relationship between clientmanagement and the auditor was a critical contextual factor impacting both theeffectiveness and efficiency of the audit. As such, rotating audit partners, as mandatedby Sarbanes-Oxley Act of 2002 Section 203 (US House of Representatives, 2002) andrecent pronouncements of audit firm rotation in the European market (EuropeanCommission, 2011), is likely to have an impact on the ACM negotiation process.

Previous research that has examined audit partner rotation has focused on the effectson the auditor (Daughertyet al., 2012), and research specific to ACM negotiations hasparalleled this research by focusing on auditor behaviour. Dopuch etal. (2001) found thatmandatory auditor rotation improved auditor independence, as evidenced by a decreasein the bias contained in the auditors reports. Wang and Tuttle (2009) extended thesefindings to document that auditors in a mandatory rotation regime were relatively lesscooperative with client management as compared to auditors in a non-mandatoryrotation regime. Wang and Tuttles experimental economics study focused on time

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periods leading up to an auditor rotation (as compared to what happens after rotation the focus of this study), and their results failed to find support that auditor rotationimpacted client managements negotiation strategies.

Outside of experimental economics, Hatfieldet al. (2011) found that auditors who

did not have prior involvement with client management proposed larger auditadjustments, as compared to auditors that did have prior involvement with a client.Hatfield et al.s results support their conclusion that auditor rotation may have abeneficial impact on the audit, at least in regard to the auditor side of the dyad in theACM negotiation task. The results from Hatfield et al. motivate two questions. First,given that ACM negotiations occur in a dyad whereby one partys actions impact theother partys response (Sanchez et al., 2007), how does auditor rotation impact thenegotiation behaviour of client management? Second, Hatfield et al. examined howauditor rotation impacted the auditors proposed audit adjustment in dollar figures;however, what negotiation strategies are used to achieve this dollar figure or resolvethe conflict? Examining negotiation strategies, rather than the proposed dollar figureaudit adjustment, is critical given that client management does not propose the auditadjustment, and different negotiation strategies can be used to achieve the same dollarFigure (McCracken et al., 2011; Goodwin, 2002; Bame-Aldred and Kida, 2007).

RapportThe ACM negotiation research hasdocumented the importance of the dyadic relationshipbetween the auditor and client management, and how it evolves over time(McCracken et al., 2008). Part of this evolution involves the development of rapport,and maintenance of established rapport between the auditor and client management(Fiolleau et al., 2013; Hunt and Price, 2002). Rapport exists as part of this interactiverelationship (Tickle-Degnen and Rosenthal, 1990) regardless of whether the ACM contextis adversarial or cooperative (Bernieri et al., 1996), and it permits each party to familiarize

themselves with the behaviours of the other party. As noted by Tickle-Degnenand Rosenthal (1990), an unfamiliar other would not be as predictable as a known other(p. 286); however, over repeated interactions, the unfamiliar others behaviour, wouldbecome more predictable, and we would learn how to accommodate ourselves to it, aswould theother to ours (p.287). As discussedbelow,developing rapport andmaintainingrapport has theoretical implications on the types of strategies used to resolve conflict.

Developing rapport: implications on distributive negotiation strategiesRapport is an amicable interaction, characterized by a personal connection betweentwointeractants (Gremlerand Gwinner, 2000, p. 92). Developing rapport, therefore, is theeffort to create this personal connection (Ross and Wieland, 1996), and prior research hasunderscored the importance of developing rapport when one party is dependent on the

other party (Bendapudi and Berry, 1997), for example, for receiving an unqualifiedaudit report. The significance of developing rapport has been documented in a variety ofcontexts including patient treatments and outcomes in medicine (Leach, 2005) andcustomer satisfaction and loyalty in business (Bendapudi and Berry, 1997). For example,Gremler and Gwinner (2008) examined how participants in the roles of customerand employee developed rapport when initiating a relationship with the other party.Their results documented that employees tried to develop rapport with customers bybeing especially attentive and courteous, to the point that their actions were not in the


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best interest of the employees company, and customers identified these sameaccommodating strategies as instrumental in developing rapport. Given that clientmanagements behaviour in resolving financial reporting issues impact the ACMrelationship (Rennieet al., 2010), this pattern of accommodating behaviour to the other

party serves to build a relationship for future interactions (Gremler and Gwinner, 2008;Thompson, 2001).

Figure 1 shows distributive negotiation strategies as a continuum. Theoretically, onone end of the continuum, contentious negotiation strategies constitute no concessionsto the other party, moderate compromising negotiation strategies constitute someconcessions, and concessionary negotiation strategies on the other end of thecontinuum, by definition, are lots of concessions. Based on the above theoreticalframework, Figure 1 shows that developing rapport with a new audit partner shifts theintended use of distributive negotiation strategies. Stated simply, building rapport willresult in conceding more, and therefore contending less. Accordingly, when clientmanagement is developing rapport with the newly rotated audit partner, we predict thatclient management will intend to use less contentious and more concessionarynegotiation strategies as compared to when there is no auditor rotation. Stated formally:

H1. Client management will intend to use contending tactics less when there isauditor rotation as compared to when there is no auditor rotation.

H2. Client management will intend to use concessionary tactics more when thereis auditor rotation as compared to when there is no auditor rotation.

Whereas the theory of rapport development provides directional predictions on clientmanagements intended use of two extreme distributive negotiation strategies(contending and conceding), it is unclear how rapport development impacts clientmanagements use of moderate negotiation strategies. Specifically, a third distributivenegotiation strategy, compromising, resides between the two extremes of contendingand conceding. As shown in Figure 1, when comparing auditor rotation to non-rotation,it is difficult to predict how compromising will be used differently. Given the lack oftheory to provide a directional prediction, we pose the following research questionto investigate the effects of auditor rotation on client managements intended use ofcompromising tactics:

Figure 1.Continuum of distributivenegotiation strategies

Contending ConcedingCompromising

Rotated Auditor

Relatively less contending (H1) & more conceding (H2)

Non-rotated Auditor

Relatively more contending (H1) & less conceding (H2)

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RQ. How does auditor rotation impact client managements intent to usecompromising tactics relative to when there is no rotation?

Established rapport: implications on integrative negotiation strategies

Rapport is dynamic with different behavioural manifestations depending uponwhether the rapport is developing (as discussed above), or whether rapport has beenestablished (Tickle-Degnen and Rosenthal, 1990). Rapport can be established byhaving a prior relationship (Nadler, 2004). In the ACM negotiation context, rapportwould be relatively established when client management has interacted with theengagement audit partner, for example, during the prior fiscal year audit (Bamber andIyer, 2007; Fiolleau et al., 2013).

Previous research, using a variety of research methods, has found that establishedrapport increases the extent of integrative behaviour and reduces the likelihood ofimpasse (Thompson, 2001). For example, examining over 2,200 federal civil cases,

Johnston and Waldfogel (2002) found that attorney pairs that have establishedrelationships are more likely to settle the case (i.e. avoid impasse) and are more timely in

their resolution as compared to attorney pairs that did not have establishedrelationships. In an experimental context using business students as participants,Moore et al. (1999) found that the presence of a previous relationship betweennegotiators established rapport which led to decreased rates of impasse. Corroboratingresults were documented by Drolet and Morris (2000) whereby in a prisoner dilemmatask, dyadic rapport increases integrative negotiation behaviour as evidenced by higher

joint outcomes. Wang (2010), in an experimental economics study, documented thatrenewable contracts that allowed for long-term established relationships resulted in alower frequency of impasse of negotiated asset fair values than one-period contracts.Finally, based on a survey of experienced negotiation mediators, Goldberg (2005, p. 369)documented that established rapport permitted respondents to generate novel orcreative solutions to the dispute. Accordingly, we predict that having establishedrapport increases the likelihood of using integrative tactics. Stated formally:

H3. Client management will intend to use integrative (problem solving andexpanding the agenda) tactics more when there is no auditor rotation ascompared to when there is auditor rotation.

Experimental methodThe experimental setting and proceduresThe experimental case was adapted from prior ACM negotiation research(McCracken et al., 2011, with permission) and was modified for the purposes of thisstudy. The adapted experimental instrument was pilot tested with undergraduateparticipants, to ensure case clarity, before using in the study. Participants were asked toassume the role of the chief financial officer of a hypothetical company and wereprovided background information of the company and its prior interactions with theexternal auditor[1]. Participants were then informed that the auditor is considering anincome-decreasing adjustment due to overstated inventory amounts, caused by bothclear cut errors and differences in estimates. In the upcoming meeting with the auditpartner, participants were asked to indicate the likelihood of using the distributiveand integrative strategies tactics to resolve the proposed inventory write downissue (Part A).


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After completing the questionnaire, participants were informed that the inventorynegotiation never came to fruition as the audit team resolved the issue and were able torender an unqualified audit opinion for the fiscal year ended December 31, 2011.Participants then proceeded to the next section of the questionnaire that asked how

they would resolve the same financial reporting issue if it were to recur in a futurefiscal year using the same list of negotiation tactics (Part B)[2]. After all completedmaterials were submitted, participants were advised that the researcher would returnlater with further instructions[3].

After an approximate two hour time delay, the researcher returned and administeredthe final section of the questionnaire that asked the participants to assume that the2012 fiscal year end audit was now taking place. Participants were randomly assignedto audit partner rotation condition (notrotated control condition versus rotated condition),and wereinformedthat the audit partner is considering an income-decreasing adjustmentdue to overstated inventory amounts caused by both clear cut errors and differences inestimates. Participants indicated the likelihood of using the same list of distributiveandintegrativenegotiation tactics to resolve thefinancial reporting issue in the upcomingnegotiation with the auditor partner (Part C)[4]. After completing the negotiationstrategy questionnaire, participants responded to debriefing questions and manipulationchecks (Part D). See Figure 2 for an illustration of the experimental procedures.

Experimental designThe experiment is a 2 1 between-participant design that manipulates audit partnerrotation (not rotated control condition versus rotated condition) and measures theparticipants intended use of 25 negotiation tactics that underlie three distributive andtwo integrative negotiation strategies.

Independent variable: audit partner rotation. A notable strength of the studysdesign is that the participants established rapport with the initial audit partner

during interactions pertaining to the previous 2011 fiscal year audit. This designfeature is held constant across all conditions as was the passage of real time betweenthe 2011 fiscal year audit part of the case and the 2012 fiscal year audit part of the case(as discussed above). In the 2012 fiscal year audit, participants were randomly assignedto either the rotated audit partner condition or the non-rotated control condition whichheld the audit partner from the previous fiscal year audit constant (Figure 2).Specifically, in the 2012 year end audit, participants in the rotation condition wereinformed that due to mandatory audit partner rotation requirements, the 2011 year endaudit partner was required to rotate off of the engagement, and would not be involved inthe fiscal 2012 year end audit. A different audit partner from the same audit firm wouldlead the audit engagement. The participants were informed that they had beenintroduced to the new audit partner previously, but had not had any working

relationship with him. By rotating only the audit partner (and not the audit firm or auditteam), the experiment controls for any potential confounds that would arise when anentire audit firm rotates (e.g. large international firm with an unblemished conservativereputation; relations between the audit staff and the accounting staff).

Dependent variables. In the upcoming negotiation with the audit partner regardingthe proposed inventory write down, participants indicated their likelihood of usingeach of the 25 negotiation tactics listed in the Appendix. These tactics represent twointegrative and three distributive strategies and were presented in random order.

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The distributive strategies consisted of contending, compromising, and concedingstrategies, with five tactics for each strategy. The integrative strategies consisted ofproblem solving and expanding the agenda strategies, again with five tactics for each

strategy. Participants were required to indicate their responses on an eight-point scaleranging from 0 (very unlikely to use) to 7 (very likely to use).

This list of negotiation tactics was adapted and extensively modified fromMcCracken et al. (2011), with permission. McCracken et al.s study extended Rahim(1983) by adapting 25 negotiation tactics related to contending, compromising,conceding, problem solving, and expanding the agenda strategies to the auditinstitutional context. Specifically, McCracken etal.s adapted measures were negotiationtactics that may be used by auditors in negotiations with client management

Figure 2.Experimental procedures

Company Background &

Financial Reporting Issue

Auditor Partner

Not Rotated (Control)

Part D

Debriefing & Manipulation Checks

Part A

Negotiation Tactics to Resolve

Financial Issue (2011 year-end)

Part B


Financial Issue If It Recurs

Auditor Partner

Rotated

Part C


Financial Issue (2012 year-end)


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(e.g. contending tactic no. 3: I would use my ability to qualify JELs financial statementsto obtain a resolution in my favor). In the current study, the adapted list of negotiationtactics were extensively modified and tailored to tactics that may be used by clientmanagement in negotiations with the auditor (e.g. contending tactic no. 3: I would try to

use my influence to fire the auditor to obtain a resolution in my favor).

ParticipantsIn total, 51 MBA students from a large university participated in the study. Themulti-part experimental materials were completed during a three-hour class in thepresence of a researcher. All participants were provided with a flat remuneration of $20and entry into a draw for $100[5].

ResultsReliability of client management negotiation strategiesThe purpose of the first two elicitations of the negotiation strategy questionnaire was

to assess the reliability of the new measures (i.e. Parts A and B). Using all dataavailable and focusing on the first elicitation of the negotiation strategy questionnaire(i.e. Part A), Cronbachs a coefficients for the contending, compromising, conceding,problem solving, and expanding the agenda tactics were 0.74, 0.79, 0.73, 0.78, and 0.61,respectively, all of which achieve reasonable levels of reliability, especially given thesmall number of tactics comprising each strategy (Tan, 2001; DeVellis, 2003)[6].

The second elicitation of the negotiation strategy questionnaire was to assesstest-retest reliability. Test-retest Pearson correlation coefficients for the contending,compromising, conceding, problem solving, and expanding the agenda strategy tacticswere 0.83 (p , 0.0001), 0.71 (p , 0.0001), 0.81 (p , 0.0001), 0.71 (p , 0.0001), and 0.71(p , 0.0001), respectively, all of which achieve reasonable levels of reliability(Nunnally and Bernstein, 1994)[7].

Experimental manipulation checksWe used two questions to examine whether participants attended to the auditorrotation manipulation. Both questions were on an 11-point scale with the endpointslabeled strongly disagree (25) to strongly agree (5) with the mid-point of zerolabeled neither agree nor disagree. The first question asked whether the auditpartner responsible for the 2012 year end audit was the same audit partner responsiblefor the 2011 year end audit whereas the second question asked whether the participant,knew the 2012 year end audit partner just as well as you knew the 2011 year end auditpartner. Summing these two measures, any participant that responded on the incorrectside of the summed scale was dropped from the analysis. This conservative approachresulted in exclusion of 11 participants leaving a total number of 39 participants for the

tests of hypotheses[8].As captured by categorical debriefing questions, the experimental participants had

a significant level of business experience as evidenced by a median level of betweenfive and ten years which is consistent with previous ACM negotiation research that hasused similar participant samples (Perreault and Kida, 2011). The majority of theparticipants held managerial-level positions at the time of the experiment, and dividingthe sample at the median position level and including this dichotomous variablein the analysis does not change the reported results[9]. Finally, participants were

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asked whether they found the case easy to understand on an 11-point scale rangingfrom 25 (strongly disagree) to 5 (strongly agree) with the midpoint of zerolabeled neither agree nor disagree. The mean response of 3.3 (SD 1.7) is statisticallysignificantly greater than the scale midpoint (t38 12.32, p(two-tailed) , 0.0001)

providing evidence that the participants understood the case context.

Experimental resultsIn the results that follow, given the acceptable Cronbachs a coefficients, we sum eachof the five tactics for each negotiation strategy to yield a composite measure for use inan ANOVA. As recommended by Tabachnick and Fidell (2007), the composite measureis the dependent measure of interest when testing the above hypotheses; however wealso subsequently examine each tactic individually.

Test ofH1: contending tactics. As an overall test ofH1, we sum the five contendingtactics to yield a composite measure (CTDSUM). As illustrated in Table I, the results ofa one-way ANOVA using auditor rotation as the independent variable and thecomposite contending measure as the dependent variable documents statistically

significant support for H1 (F 4.66, p(one-tailed) 0.019); that is, client managementintends to use the contending tactics less when there is audit partner rotation ascompared to when the audit partner is not rotated. Examining the contending tacticsindividually, the results of one-way (auditor rotation) ANOVAs using the respectivecontending tactic as the dependent variable provides further support for H1.Specifically, two of the contending tactics are statistically significant (CTD3 andCTD4), and two tactics are marginally significant (CTD2 and CTD5).

Test ofH2: concessionary tactics. To provide an overall test ofH2, we again sum thefive concessionary tactics to yield a composite measure (CEDSUM). Documented inTable II, the results of a one-way ANOVA using auditor rotation as the independentvariable and the composite concessionary measure as the dependent variable yieldsmarginally significant support for H2 (F 2.63, p(one-tailed) 0.057) whereby clientmanagement intends to use the concessionary tactics more when there is audit partnerrotation as compared to when the audit partner is not rotated. Examining theconcessionary tactics individually, the results of one-way (auditor rotation) ANOVAsusing the respective concessionary tactic as the dependent variable provides further

Rotation

One-way ANOVA

Tactic

Audit partnerconstant condition

Mean (SD)

Audit partnerrotation condition

Mean (SD) DF Type III SS F-value p-valuea

CTD1 2.49 (1.74) 1.86 (1.79) 1 3.679 1.19 0.141CTD2 2.97 (1.85) 1.91 (2.03) 1 10.457 2.83 0.051

CTD3 1.65 (1.74) 0.60 (0.61) 1 10.446 5.34 0.013CTD4 4.12 (1.67) 2.81 (2.10) 1 16.174 4.68 0.019CTD5 3.14 (1.92) 2.10 (2.01) 1 10.189 2.66 0.056 CTDSUM 14.37 (6.93) 9.29 (7.65) 1 243.288 4.66 0.019

Notes: aTabulated p-values are one-tailed only when in the hypothesized direction; otherwisetwo-tailed; italicized tactics are either statistically significantly (p , 0.05) or marginally (p , 0.10)different; each tactic is described in the Appendix; participants were required to indicate theirresponses on an eight-point scale ranging from 0 (very unlikely to use) to 7 (very likely to use)

Table I.Analysis ofH1:

descriptive statistics andunivariate analysis of

contending tactics


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support forH2. Two of the concessionary tactics are statistically significant (CED1 andCED3), and one tactic is marginally significant (CED2).

Test of RQ: compromising tactics. To investigate the research question, we firstexamine the descriptive statistics contained in Table III and note that all fivecompromising tactics are consistently in the same direction such that client managementintends to use the compromising tactics more when the audit partner is held constant ascompared to when the audit partner has rotated. A composite measure is created bysumming the five compromising tactics (COMPSUM). Providing support for the aboveconjecture, a one-way ANOVA using auditor rotationas the independent variableandthecomposite compromising measure as the dependent variable yields marginallysignificant results (F 3.36, p(two-tailed) 0.075)[10]. Examining the compromising

tactics individually, the results of one-way (auditor rotation) ANOVAs using therespective compromising tactic as the dependent variable documents that onecompromising tactic is statistically significant (COMP1) and another tactic achievesmarginal levels of statistical significance (COMP2).

Rotation

One-way ANOVA

Tactic


Mean (SD)



COMP1 4.55 (1.35) 3.50 (1.69) 1 10.360 4.63 0.038 COMP2 4.05 (1.83) 2.99 (2.06) 1 10.696 2.88 0.098

COMP3 4.33 (1.16) 3.76 (1.56) 1 3.044 1.70 0.200COMP4 2.93 (1.38) 2.38 (1.50) 1 2.911 1.42 0.241COMP5 2.30 (1.53) 2.04 (1.63) 1 0.629 0.25 0.617COMPSUM 18.16 (4.67) 14.66 (7.25) 1 115.195 3.36 0.075

Notes: aThep-values in this table are two-tailed due to the non-directional research question; italicizedtactics are either statistically significantly (p , 0.05) or marginally (p , 0.10) different; each tactic isdescribed in the Appendix; participants were required to indicate their responses on an eight-pointscale ranging from 0 (very unlikely to use) to 7 (very likely to use)

Table III.Analysis ofRQ:descriptive statistics andunivariate analysis ofcompromising tactics

Rotation

One-way ANOVA

Tactic


Mean (SD)



CED1 3.86 (1.60) 4.95 (1.41) 1 11.236 4.70 0.019CED2 4.41 (1.59) 4.74 (1.57) 1 3.467 1.71 0.099CED3 3.44 (1.78) 4.59 (1.34) 1 12.143 4.52 0.020 CED4 2.63 (1.59) 3.06 (2.11) 1 2.504 0.75 0.196CED5 3.86 (1.84) 3.64 (2.15) 1 0.443 0.11 0.737CEDSUM 18.21 (5.84) 21.40 (6.07) 1 92.464 2.63 0.057


Table II.Analysis ofH2:descriptive statistics andunivariate analysis ofconcessionary tactics

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Test of H3: integrative tactics. Focusing on the first integrative strategy, problemsolving, we first examine the descriptive statistics contained in Table IV Panel A andnote that four of the five problem solving tactics, and the summed composite measure(PSSUM), are in the direction predicted by H3. However, the results of a one-way

ANOVA using auditor rotation as the independent variable and the composite problemsolving measure as the dependent variable yields statistically non-significant results.Further, the results of one-way (auditor rotation) ANOVAs using the respectiveproblem solving tactic as the dependent variable documents that only a single tactic(PS3) marginally supportsH3.

For the second integrative strategy, we sum the five expanding the agenda tactics toyield a composite measure (EASUM). As illustrated in Table IV Panel B, the results ofa one-way ANOVA using auditor rotation as the independent variable and theexpanding the agenda composite measure as the dependent variable documentsstatistically significant support for H3 (F 2.92, p(one-tailed) 0.048); that is, clientmanagement intends to use the expanding the agenda tactics more when there has notbeen audit partner rotation as compared to when audit partners have rotated.

Examining the expanding the agenda tactics individually, the results of one-way(auditor rotation) ANOVAs using the respective expanding the agenda tactic as thedependent variable provides further support forH3. Specifically, one of the expandingthe agenda tactics is statistically significant (EA4) and two other tactics achievemarginal levels of statistical significance (EA1 and EA5)[11].

Additional analysisTo examine whether the above theory generalizes to a different sample of participantswith greater accounting experience, we conducted a replication of the experiment

Rotation

One-way ANOVA

Tactic


Mean (SD)



Panel A: descriptive statistics and univariate analysis of problem solving tacticsPS1 5.63 (1.49) 6.05 (0.93) 1 1.696 1.01 0.321PS2 5.43 (1.02) 5.13 (2.09) 1 0.906 0.38 0.271

PS3 5.74 (0.69) 5.20 (1.81) 1 2.743 1.70 0.100PS4 5.02 (1.37) 4.46 (2.08) 1 2.905 1.01 0.161PS5 5.21 (1.35) 5.20 (1.48) 1 0.001 0.00 0.492PSSUM 27.03 (3.95) 26.04 (6.00) 1 9.222 0.39 0.269

Panel B: descriptive statistics and univariate analysis of expanding the agenda tacticsEA1 2.45 (1.52) 1.70 (1.65) 1 5.339 2.15 0.076EA2 5.21 (1.43) 5.35 (1.28) 1 0.188 0.10 0.754

EA3 5.56 (1.26) 5.69 (1.06) 1 0.162 0.12 0.736EA4 2.48 (1.75) 1.35 (1.28) 1 12.012 4.83 0.017EA5 2.17 (1.55) 1.46 (1.71) 1 4.660 1.78 0.095EASUM 17.86 (4.14) 15.55 (4.18) 1 50.389 2.92 0.048


Table IV.Analysis ofH3:

integrative negotiationtactics


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(Lindsay and Ehrenberg, 1993). The previous multi-part experimental materials wereadapted to a single-part experiment, which provided details of the interactions with the2011 fiscal year audit partner. In the 2012 fiscal year audit, participants were randomlyassigned to audit partner rotation condition (not rotated control condition versus rotated

condition). Participants indicated their likelihood of using each of the 25 negotiationtactics to resolve the financial reporting issue in the upcoming negotiation with theauditor partner. All other aspects of the case were the same as the main study(e.g. financial reporting issue, nature of previous interactions with the auditor, etc.).

A total of 67 accounting practitioners attending a graduate program from a largeuniversity participated in the study outside of class in the presence of a researcher withno remuneration. Consistent with the main study, one participant that responded onthe incorrect side of the summed manipulation check scale was excluded from theanalysis. The participants rated the case easy to understand and reported that thefinancial reporting issue was easy to understand[12]. Finally, this sample ofparticipants had a greater level of accounting experience than the previous MBAsample as evidenced by the self-reported accounting experience and number ofaccounting classes completed[13].

Focusing first on the composite contending measure as the dependent variable, theresults of a one-way (auditor rotation) ANOVA found the rotation condition mean of14.7 (SD 5.1) to be less than the non-rotated control condition mean of 18.6 (SD 5.2)providing statistically significant support for H1 (F 9.59, p(one-tailed) 0.001).Second, focusing on the composite concessionary measure as the dependent variable,the results of a one-way (auditor rotation) ANOVA found the rotation condition meanof 19.2 (SD 7.7) to be greater than the non-rotated control condition mean of 16.8 (SD 6.5)yielding marginally significant support for H2 (F 1.90, p(one-tailed) 0.087). Third,focusing on the composite problem solving measure as the dependent variable, theresults of a one-way (auditor rotation) ANOVA found the non-rotation control

condition mean of 29.4 (SD 4.2) to be greater than the rotation condition mean of 27.1(SD 5.2) documenting statistically significant support for H3 (F 4.00,p(one-tailed) 0.025). Lastly, although in the same direction as the results documentedin the main analysis, the results of one-way (auditor rotation) ANOVAs using theexpanding the agenda composite measure and the compromising composite measureas the dependent variables yield non-statistically significant results (results nottabulated)[14].

Discussion and conclusionThis study investigates how auditor rotation impacts the negotiation strategies usedby client management to resolve a financial reporting issue with the external auditor.The results of an experiment document that rotation of the audit partner causes client

management to intend to use relatively less contending and more concessionary tactics.That is, client management intends to be relatively accommodating to the newlyrotated audit partners proposed audit adjustment, consistent with the theory thatinitial encounters focus on rapport development. Further, consistent with research onestablished rapport, the results support that client management intends to use moreintegrative tactics with the non-rotated audit partner as compared to the rotated auditpartner. Likewise, in regard to a moderate distributive negotiation strategy,compromising, the results indicate that client management intends to use more

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compromising tactics with the non-rotated audit partner as compared to the rotatedaudit partner. The consistent pattern of results in these latter two findings indicatesthat established rapport facilitates co-operation to resolve the financial reporting issue(rather than accommodation).

These finding suggest mandated partner rotation required by the Sarbanes-OxleyAct of 2002 Section 203 (US House of Representatives, 2002) and audit firm rotationadvocated by the European Commission (2011) has implications on not only auditorbehaviour and independence, but also the behaviour of client management. Whereasprevious ACM negotiation research has documented the benefits of auditor rotation byexamining auditor behaviour (Hatfieldet al., 2011), this study documents the meritsand costs of auditor rotation by examining client management behaviour in an ACMnegotiation. Specifically, client management develops rapport with the newly rotatedauditor by intending to be more concessionary and less contentious(i.e. accommodating). However, these merits of auditor rotation come at a potentialcost, as client management intends to use relatively more integrative andcompromising tactics when rapport has been established with the non-rotated auditpartner (i.e. co-operative).

There are several limitations to be noted. The study focused exclusively on theimpact of audit partner rotation on a specific audit task ACM negotiation. Policydecisions related to auditor rotation should consider all other aspects of the audit and,in addition to the experimental methods strength of causality, be sensitive to absolutemagnitude of effect sizes. Further, the study did not manipulate audit firm rotation, butrather only manipulated whether the audit partner rotated. Although this provides anavenue for future research, from an internal validity perspective, this choice inexperimental design was necessary for the current study to control for potentialconfounds that would exist when a firm rotates (e.g. large international firm with anunblemished conservative reputation; relations between the audit staff and the

accounting staff). In addition, the dependent variables used in this study measured theintended use of negotiation tactics and a notable strength of the studys designpermitted insights into the reliability of the dependent variables (e.g. test-retestreliability); however, intended use is not necessarily equivalent to the actual use ofnegotiation tactics and different behaviours may manifest as negotiations proceed.Although intended use impacts actual use (Ajzen, 1991), future research may explicitlyexamine actual negotiation behaviour. Further, although participants found the case tobe realistic, the data relates to a single case (e.g. inventory overstatement due to clearcut errors and differences in accounting estimates). Future research may examinedifferent accounting contexts (e.g. expertise of client management, nature ofmisstatements, engagement partners history of negotiation strategies, etc.).

Participants in the study were MBA students with business and managerial

experience. Although these participants are comparable to participant samples used byprior research (Perreault and Kida, 2011), the participants served as a surrogate forclient-management. Additional analysis yielded evidence that the studys theorygeneralized to a different sample of participants that had a greater level of accountingexperience. However, a notable difference between the study and the additionalanalysis lies in the intended use of integrative tactics (problem solving and expandingthe agenda). In the study, H3 was supported as it related to expanding the agendatactics, but not in regard to problem solving tactics. In contrast, the additional analysis


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found support for H3 as it related to problem solving tactics, but not in regard toexpanding the agenda tactics. Although the findings in both the study and theadditional analysis support the studys theory that established rapport increases thelikelihood of using integrative tactics, future research on the use of integrative

strategies is warranted.From an audit quality perspective, examining client managements behaviour and

use of negotiation tactics is critical given that the ACM negotiation occurs in a dyadwhere one partys behaviour influences the other partys response. This studycontributes to the literature by providing timely evidence to inform the debate of themerits and costs of auditor rotation. Although prior research has questioned the costsof audit partner rotation (Daugherty et al., 2012), this study documents that auditorrotation may improve auditors ability to achieve their negotiation outcome by reducedcontentiousness and increased concessionary behaviour by client management.However, the results of the study also document that, insofar as it is beneficial to haveclient management intend to use integrative behaviour, there may also be benefits fromauditor tenure in an ACM negotiation context.

Notes

1. Previous interactions with the external audit partner were described to be professional andrespectful given that the literature has documented that audit partners with poorrelationships with client management tend to be removed from the engagements(McCracken et al., 2008; Beattie et al., 2000). The experimental design choice to describeinteractions with the external auditor in the text of the experimental instruments mitigatespotential confounds that may arise during face-to-face interactions. Moreover, the literaturehas documented that rapport develops in text/narrative based contexts (Walther, 1992;Braeutigam, 2006; Greenet al., 2004).

2. As will be discussed below and unbeknownst to participants, the purpose of eliciting the

tactics twice was to provide empirical support for the reliability of the adapted dependentmeasures.

3. Refer to the participants section below for further details.

4. Participant fatigue is safeguarded by both the passage of real time between parts of thequestionnaire and that Parts C and D together only took the participants on averageapproximately 10 minutes to complete. For internal validity purposes, the magnitude andnature of the 2011 and 2012 misstatements were held constant at the potential cost ofmundane realism (Peecher and Solomon, 2001).

5. The class material dealt with managerial accounting and control systems. During the classand in the class materials, no reference was made whatsoever to auditors, auditor rotation,or negotiations.

6. The relatively lower Cronbachs acoefficient for the expanding the agenda tactics (i.e. 0.61

with a test-retest reliability of 0.71) parallels the Cronbachs areported in McCrackenet al.(2011) (0.67 as per their footnote [13]).

7. The second elicitation of the negotiations strategy questionnaire (i.e. Part B) again yieldedreasonable levels of reliability as evidenced by the Cronbachs a coefficients of 0.78, 0.85,0.81, 0.73, and 0.61 for the contending, compromising, conceding, problem solving, andexpanding the agenda tactics, respectively.

8. One participant was not able to be present for the second part of the study (i.e. Parts C and D)and hence is not included in the experimental results. A more stringent approach of

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removing participants who answered each manipulation check incorrectly (rather than usingthe sum of the two questions) yields similar results. Further, focusing on only the39 experimental participants, measures of reliability are similar to those previously reported.

9. Specifically, the position level variable is not significant nor did it interact with the rotation

variable in any of the five composite measure models (CTDSUM, CEDSUM, COMPSUM,PSSUM, and EASUM). Examining the 25 negotiation tactics individually, the position leveldid not interact with the rotation variable in any of the models. Further, in only two instances(CED4 and PS3) did the position level main effect approach marginal statistical significance(p 0.084 andp 0.074, respectively). In these two instances, the reported rotation resultsand inferences remain unchanged, and when considering the number of contrasts, theoccurrence of two marginal instances is far below significance.

10. Reportedp-values for the effects of auditor rotation on client managements compromisingtactics are two-tailed given the non-directional research question.

11. Tabachnick and Fidell (2007, p. 268) note that, Using very highly positively correlated[dependent variables] in MANOVA is wasteful [. . .] Better strategies are to [. . .] create acomposite score [. . .] for use in ANOVA. Accordingly, the above analyses use a composite

score to investigate the hypothesized differences. Not surprisingly given the highly correlatednegotiation tactics documented previously by the Cronbachsa coefficients and small samplesize, the results of MANOVAs for each negotiation strategy using both Wilks l andHotellingst2 statistics did not detect differences across conditions. Further, we recomputedthe above ANOVAs including in the models a summed covariate of the same tactic based onthe previous administration in Parts A and B. Inclusion of the covariate did not change thelevel of significance for the contending tactics (H1), increased the level of statisticalsignificance for the conceding tactics (H2), reduced the level of significance for the expandingthe agenda tactics (H3), did not change the level of significance for the problem solving tactics(H3), and removed the statistical significance for the compromising tactics (RQ).

12. The former debriefing question asked whether the participant found the case easy tounderstand on an 11-point scale ranging from 25 (strongly disagree) to 5 (stronglyagree) with a midpoint of zero. The mean response of 3.9 (SD 1.1) is statistically

significantly greater than the scale midpoint (t65 29.53, p(two-tailed) , 0.0001). The latterdebriefing question, which was not elicited in the main study, asked whether the participantunderstood the financial reporting issue (i.e. inventory obsolescence) on an 11-point scaleranging from 25 (did not understand) to 5 (completely understand) with a midpoint ofzero. The mean response of 3.7 (SD 1.1) is statistically significantly greater than the scalemidpoint (t65 26.86,p(two-tailed) , 0.0001).

13. The former debriefing question asked the participant to describe their financial reporting oraccounting experience on an 11-point scale ranging from 0 (no experience) to 10(very extensive experience). The mean response of 5.1 (SD 1.6) for the accountingpractitioner sample is statistically significantly greater than mean response of 3.3 (SD 1.8) forthe MBA sample (F 26.97,p(two-tailed) , 0.0001). The latter debriefing question asked theparticipant to indicate how many accounting classes have you taken. The mean response

of 11.2 (SD 4.2) for the accounting practitioner sample is statistically significantly greaterthan mean response of 3.4 (SD 1.8) for the MBA sample (F 119.26,p(two-tailed) , 0.0001).

14. The increased statistical power afforded by the larger sample size enhanced the multivariateanalysis. Specifically, the results of a one-way (auditor rotation) MANOVA using the fivecontending tactics as dependent variables yielded statistically significant results (Wilksl 0.803, F(5,60) 2.95, p(one-tailed) 0.0095) with three of the five tactics individuallystatistically significant (CTD1, CTD2 and CTD4). The results of a one-way (auditor rotation)MANOVA using the five concessionary tactics as dependent variables yielded marginallysignificant results (Wilks l 0.869,F(5,60) 1.81,p(one-tailed) 0.0623) with one individual


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tactic statistically significant (CED4) and another marginally significant (CED1). The resultsof a one-way (auditor rotation) MANOVA using the five problem solving tactics asdependent variables yielded non-statistically significant results (Wilks l 0.901,

F(5,60) 1.32, p(one-tailed) 0.1345) with two individual tactics statistically significant

(PS1 and PS4) and another marginally significant (PS3). The results of one-way (auditorrotation) MANOVAs using the five compromising tactics as dependent variables and thefive expanding the agenda tactics as dependent variables both yielded non-statisticallysignificant results (results not tabulated).

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Appendix. Distributive strategiesContending tactics

CTD1 I would use my influence to get my position accepted by the auditor.

CTD2 I would argue with the auditor to show them the merits of my position.CTD3 I would try to use my influence to fire the auditor to obtain a resolution in my favor.

CTD4 I would be firm in pursuing my position.

CTD5 I would use my expertise in the business to influence the resolution in my favor.

Concessionary tactics

CED1 I would try to satisfy the expectations of the auditor.

CED2 I would try to satisfy the needs of the auditor.

CED3 I would attempt to accommodate the wishes of the auditor.

CED4 I would give into the wishes of the auditor.CED5 I would make concessions from my position to the auditor.

Compromising tactics

COMP1 I would propose some middle ground on this issue at some point during the processof resolving the disagreement with the auditor.

COMP2 I would negotiate with the auditor so that a compromise could be reached.

COMP3 I would try to find some middle ground to resolve this issue with the auditor.

COMP4 I would use give and take so that a compromise could be made with the auditor.

COMP5 I would try to play down the differences with the auditor to reach a compromise.

Integrative strategiesProblem solving tactics

PS1 I would try to bring all my concerns about this issue out into the open with the auditorso that the issue could be resolved in the best possible way.

PS2 I would try to investigate the issue further with the auditor to find a new solutionacceptable to both of us.

PS3 I would try to work with the auditor to find new solutions to this issue that satisfy bothof our expectations.

PS4 I would try to integrate my ideas about how to resolve this issue with the auditor tocome up with a new solution jointly.

PS5 I would collaboratewiththeauditorto comeup witha new solutionacceptable toboth ofus.

Expanding the agenda tactics

EA1 I would bring other issues I have with the audit to the discussion, such that I couldtrade off on other issues to resolve this issue in my favor.

EA2 I would try to work with the auditor to develop a proper understanding of this issue inthe context of other issues.


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EA3 I would provide all relevant information to the auditor so we could solve this issuetogether in the context of other issues.

EA4 I would attempt to find other issues with the auditors work, which I could add to thediscussion.

EA5 I would attempt to find other issues with the audit work, so I could accede to theirwishes at the same time as achieving my position on this issue.

About the authorsRegan N. Schmidt is an Assistant Professor at the University of Saskatchewan. Regan N. Schmidtis the corresponding author and can be contacted at: [email protected]

Britney E. Cross is a graduate student at the University of Saskatchewan.

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