Investigating the role of interchangeable auditor positions: Does swapping hats impact audit quality

Abstract

Abstract Purpose: This study investigates the effects of the alternating roles of audit firms on audit quality. Specifically, we examine whether appointing a previous external (internal) audit firm as an incumbent internal (external) audit firm impacts audit quality. We analyze the economic bonding and knowledge spillover hypotheses associated with these role transitions. Design/methodology/approach: Drawing on a dataset of 1,092 firm-year observations of Omani firms from 2005 to 2020, we utilize a more robust research design to demonstrate this effect. Specifically, we use difference-in-differences, propensity score matching, and fixed effects models to examine the developed hypotheses. Findings: Our findings reveal that designating a former internal (external) audit firm as the current external (internal) audit firm results in a notable decrease (increase) in earnings quality. These results robustly support the economic bonding (knowledge spillover) hypothesis when internal (external) auditors switch to external (internal) auditors. We control for variables such as outsourced internal audit functions, alternative measures for discretionary accruals, and endogeneity. Importantly, our main results withstand these supplementary tests. We also uncover the influence of audit committee quality and audit firm type on auditor role switching outcomes. Additionally, we find an overlooked incentive for external auditors to transition that is rooted in the drive to enhance auditor efficiency by embracing outsourced internal audit responsibilities. Originality: This study contributes novel theoretical and practical insights by expanding the scholarly discourse in uncharted directions.