Possible Threats against Auditor Independence

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Mandatory Rotation

Another proposals mentioned in the Green Paper is to apply mandatory rotation of audit firms (European Commission, 2010). Today rotation of the key audit partner is required. This implies that the key audit partners must be replaced within seven years of appoint-ment and the replaced auditor cannot return to the audit engagement team until two years have passed (European Commission, 2002). Auditor independence is, as already men-tioned, of great importance to stakeholders, therefore the Commission seeks to enhance auditor independence by establishing mandatory rotation of audit firms. However manda-tory rotation of audit firms is very controversial and there are separate views on the matter (Ruiz-Barbadillo, Gòmez-Aguilar and Carrera, 2009). Below arguments for and against mandatory rotation of audit firms will be presented.
Those who support mandatory rotation of audit firms note that such a regulation would avoid long- term relationship between the auditor and the audit client and thereby reducing the risk of familiarity or trust (Arel, Brody and Pany, 2005). Jennings, Pany and Reckers (2006) argue that a long-term audit engagement makes it more difficult for the auditor to be objective as it creates an audit-client relationship where the auditor may develop ties of friendship. Both economical and personal interest in the audit client increases the risk of an auditor to overlook essential faults in the organization. As mandatory rotation of audit firms would reduce the risk of familiarity or trust the perceived independence would be enhanced.
Bazerman, Loewenstein and Moore (2002) argue that the even the most honest and thor-ough auditor can make unintentional mistakes as a result of the close relationship between auditor and the audit client. The explanation to this phenomenon is “self-serving bias” where people unconsciously and unintentionally can make decisions which will benefit themselves. In the situation of mandatory rotation of audit firms this scenario would be eliminated as the auditor has no focus on keeping the audit engagement. No matter of his/her actions there is a time limit on the audit engagement, so the auditor will have no self-interest other than to be completely objective. Thereby mandatory rotation of audit firms would also enhance independence of mind (Arel et al., 2005).
There are also a number of arguments which oppose mandatory rotation of audit firms. Many of those who oppose mandatory rotation of audit firms claim that it is not necessary to enhance auditor independence as audit firms and auditors already strive to be independ-ent. An auditor must strive to be independent to maintain a good reputation; endangering auditor independence may very well lead to a bad reputation which in turn would result in higher costs. So, the auditor will feel motivated to maintain and strengthen his independ-ence in order to keep a good reputation (Ruiz-Barbadillo et al., 2009). In many situations auditors need special expertise for each specific client, to gather new information and to become an expert is time-consuming which in turn leads to higher costs for the audit client. Another argument against mandatory rotation of audit firms is that it will harm the quality of the audit. During the first few years of an audit engagement the probability of significant errors to occur is higher as it takes time for the auditor to become familiar with the client’s operations (Jackson, Moldrich and Roebuck, 2008).

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Green Paper

The Commission presents Green Papers’ which concern a particular area within politics. Green Papers include proposals and ideas on how to change different areas which are un-der discussion. The purpose of Green Papers are to open a discussion and receive opin-ions and standpoints by those concerned as well as other interested parties (European Commission, 2012).
Jönköping International Business School Rani Afrem 1996 Green Paper
In 1996 the Commission presented the Green Paper: The role, the position and the liability of the statutory auditor within the EU. The 1996 Green Paper discusses the role and inde-pendence of an auditor as a result of several financial scandals. The quality of an audit was questioned as the role, position and liability of an auditor did not correspond across the EU (European Commission, 1996a).
Even though the main focus of the 1996 Green Paper was to harmonize the auditor’s role across member states certain questions such as prohibition of non-audit services and man-datory rotation of audit firms were brought up. In 1996 the competition among audit firms had increased, as a result audit engagement fees were lowered. To compensate for the low-er audit fees many audit firms began to offer non-audit services. This created a discussion on whether non-audit services compromised auditor independence and if non-audit ser-vices should be banned (European Commission, 1996a). The 1996 Green Paper resulted in a new approach to auditing aimed to harmonize the audit profession throughout the EU. Proposals on prohibition of non-audit services and mandatory rotation of audit firms were however not discussed further (European Commission, 1996b).

1 Introduction
1.1 Background
1.2 Problem Discussion .
1.3 Research Questions .
1.4 Purpose .
2 Review of Literature
2.1 History of the Audit Profession
2.2 The Concept of Auditing
2.3 The Auditor’s Role
2.4 Independence
2.5 Possible Threats against Auditor Independence
2.6 Green Paper
2.7 Rules and Regulations
2.8 Recent Proposal on Reform of the Audit Market
2.9 Importance of Shareholders
3 Method
3.1 Choice of Subject
3.3 Data Collection
3.4 Quality Assessment
4 Empirical Findings
4.1 Alliance Trust Plc.
4.2 Association of British Insurers
4.3 Association of Pension Funds Management Companies
4.4 AVIVA
4.5 BlackRock Inc.
4.6 CFA Institute
4.7 Dutch Shareholders Association (VEB)
4.8 Eumedion
4.9 Hermes Equity Ownership Services
4.10 International Corporate Governance Network .
4.12 Irish Funds Industry Association .
4.13 Local Authority Pension Fund Forum
4.14 Proxinvest & ECGS .
4.15 Railpen Investments
4.16 Standard Life Investments
4.17 Swedish Shareholders’ Association.
4.18 The British Venture Capital Association
4.19 The California Public Employees’ Retirement Systems .
4.20 Commission’s Proposal on Reform of the Audit Market
5 Analysis .
6 Conclusion