The Impact of Auditor Selection Process and Audit Committee Appointment Power on Investment Recommendations

After the recent financial crisis and corporate failures, regulatory bodies have proposed and, in some cases, enacted alternative auditor selection processes such as mandatory audit firm rotation or mandatory tendering. However, there is limited empirical evidence of the efficacy of auditor selection processes. Further, although in many countries the audit committee has the authority to appoint the external auditor, in practice management frequently has substantial influence over such decisions. We posit that the appointment power of the audit committee will impact the effectiveness of the auditor selection process and vice versa. In this experimental study involving 118 experienced investment professionals, we examine the impact of the auditor selection process (mandatory rotation, mandatory tendering, and voluntary selection) and the appointment power of the audit committee (high, low) on investment recommendations. The results indicate that, first, audit committee appointment power affects investment recommendations only when a possible auditor change is anticipated (i.e., in the case of rotation and tendering), but not when the auditor selection is voluntary. Second, rotation and tendering both lead to a higher recommended investment likelihood than voluntary selection when an audit committee has high appointment power. However, when the audit committee has low appointment power, all auditor selection processes result in an equally low recommendation likelihood. In all, the results highlight that the auditor selection process and audit committee appointment power are not viewed in isolation from each other.