The objective of this exploratory study was to investigate whether a ...

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The objective of this exploratory study was to investigate whether a ...


    The Effects of a Cooling-Off Period on the Perceived

    Independence of External Auditors

    Carl N. Wright

    Associate Professor and Chairman, Department of Accounting and Finance

    Virginia State University

    P.O. Box 9047

    Petersburg, VA 23806

    Fax 804-524-5400

    Telephone 804-524-5841


    Quinton Booker

    Professor and Chairman, Department of Accounting

    Jackson State University

    P.O. Box 17970

    Jackson, MS 39217

    Fax 601-979-2690

    Telephone 601-979-2704



    The Effects of a Cooling-Off Period on the Perceived

    Independence of External Auditors

    Carl N. Wright

    Virginia State University

    Quinton Booker

    Jackson State University

    ABSTRACT: Senior-level employees of CPA firms sometime leave the firms and accept employment with entities that their firms audit. This is often referred to as the revolving-door phenomenon. Little empirical evidence is available regarding the impact that the revolving-door phenomenon has on perceptions of firms‟ independence. Some believe that a break in service, a

    cooling-off period, is needed between employment with the firms and the clients to preserve CPA firms‟ independence for future audits. The study used members of state boards of accountancy to examine this issue. A between-subjects design was used. Nonpublic companies were used in three experimental scenarios that included the revolving-door phenomenon with no cooling-off period, a one-year cooling-off period, and a two-year cooling-off period. Findings indicated that a one-year cooling-off period had a significant positive impact on perceptions of independence of a CPA firm and whether the CPA firm should have been allowed to perform the independent audit. However, increasing the length of the cooling-off period from one year to two years failed to significantly change these results. A one-year cooling-off period is recommended to mitigate the negative impact of the revolving-door phenomenon.

Key Words: CPA Firms’ Independence, Revolving-Door Phenomenon, Cooling-Off




    This study identifies and compares the relative effects of three cooling-off period scenarios on State Board of Accountancy members‟ perceptions of certified public accounting (CPA) firms‟ independence and whether the firm should be allowed to perform the audit when

    non-public companies are involved in the revolving-door phenomenon. The revolving-door phenomenon occurs when audit clients employ former auditors, usually audit managers and partners of their current CPA firms, in key accounting positions. A cooling-off period is the time period of disassociation of the former auditor from the audit client‟s CPA firm before accepting employment with the audit client. The revolving-door phenomenon was investigated due to its possible negative impact on audit firm independence. Accordingly, a cooling-off period was considered by this study as a means to mitigate the possible negative impact of the revolving-door phenomenon on CPA firms‟ independence. Over 25 years ago Imhoff (1978) estimated that

    18.55% of auditors would accept employment with their former CPA firms‟ clients.

    The Imhoff (1978) study was designed to evaluate CPA firms‟ perceived independence

    impairments posed by the revolving-door phenomenon. The perception of CPA firms‟

    independence was studied for bankers‟ and financial analysts‟ as one group compared with those

    of CPAs as another group. The comparisons were made using hypothetical cases designed to permit the impact of two variables on perceived CPA firms‟ independence to be evaluated: (1)

    the time lapse between when the former auditor, now the client‟s employee, audited the client and began working for the client; and (2) the position, supervisory or non-supervisory, now held by the former auditor who is now employed by the former auditor‟s CPA firm‟s audit client.

    Evidence from the Imhoff (1978) suggested that both variables, in certain combinations, positively and negatively impacted both groups‟ perceptions of CPA firms‟ independence due to


    the presence of the revolving-door phenomenon. As such, the Imhoff (1978) study and its design served as the prime underpinning for this research.

    1More recently the Independence Standards Board (ISB) acknowledged the existence of

    the revolving-door phenomenon and that it enticement often allows public accounting firms to recruit highly qualified audit staffs (ISB, Independence Standard No. 3, 2000, par. 24). However,

    2the Sarbanes-Oxley Act of 2002 requires a one-year cooling-off period for publicly held

    companies that employ their current CPA firms‟ former auditors in senior-level accounting

    positions. According to this Act, the employment of former audit team members with the public client raises independence concerns related to the CPA firms conducting the audit. The Act indicates that CPA firms, whose former auditor accepts a position with an audit client as chief executive office, controller, chief financial officer, chief accounting officer or equivalent without a one-year cooling-off period, cannot continue to audit that client. This law contains a section that indicates that state boards of accountancy should make an independent determination of whether a similar requirement is necessary for CPA firms for non-public companies under their jurisdiction (Sarbanes-Oxley Act, 2002, sec. 209). This study addresses issues relative to independence, the revolving-door phenomenon and a cooling-off period in the nonpublic company environment. Since CPAs serving nonpublic entities are under the regulatory jurisdiction of state boards of accountancy as opposed to the SEC, perceptions of members of state boards are investigated. State boards of accountancy have the legal responsibility to regulate the professional relationships between CPA firms and the firms‟ non-public audit clients.

     1 The ISB was the private sector standard-setting body that governed the independence of auditors as related to their public company clients. The ISB dissolved itself on July 31, 2001. 2 A cooling-off period is a time period when the former auditor has disassociated himself/herself from the prospective audit-client employer whose current audit firm is also the audit firm of the former auditor. Some define the auditor‟s disassociation as an absence from the audit firm; while others define the disassociation as an absence from the audit team that performs the audit of the audit client in question. It appears that the Sarbanes-Oxley Act of 2002 uses the latter definition of disassociation. For this study, the former definition is used.


    State boards of accountancy establish guidelines of independence and determine the services that CPA firms are allowed to perform for non-public clients within their jurisdiction. One of the purposes of such guidelines is to protect the investing public. As such, state boards of accountancy are advocates for users of audited financial information. CPA firms are required to follow the guidelines promulgated by state boards of accountancy. Failure to do so could result in state boards of accountancy imposing sanctions or other penalties to include the revocation of CPA firms‟ state licenses to practice. As public regulators and advocates for users of audited financial information of non-public companies, state boards of accountancy members‟

    perceptions of audit firms‟ independence are important—especially when non-public clients

    employ their current CPA firms‟ former auditors in senior-level accounting positions. Therefore,

    members of state boards of accountancy were used in this study.

    The remainder of this paper is organized as follows. The next section provides background information. The third section addresses research questions and is followed by a section on the research design. Final sections address research results, summary, conclusions, future research recommendations, and limitations.


     Independence is the foundation of the attestation function. The second general standards of generally accepted auditing standards (GAAS) indicate that “in all matters relating to

    assignment, an independence in mental attitude is to be maintained by the auditor or auditors" (AICPA, 2001, para.01). This section continues by indicating that “the auditor must be without bias with respect to the client under audit since otherwise he would lack that impartiality


    necessary for the dependability of his findings, however excellent his technical proficiency may be” (para. 02).

    The primary reason for the clear directive that the auditor must be independent is to ensure that users of audited financial statements have confidence that they can rely on the auditor‟s work. Paragraph three indicates that “Independent auditors should not only be independence in fact; they should avoid situations that may lead outsiders to doubt their independence.” The revolving-door phenomenon is viewed by some as a significant threat to

    3auditor independent. On March 20, 2002, the Financial Executives International (FEI)

    recommended to the U.S. House of Representatives Financial Services Committee that companies adopt policies that restrict the hiring of engagement audit and tax partners, or senior- audit and tax managers, who have worked on the affected company‟s audit for a period specified by the board of directors. FEI believes that this period should be no shorter than two years (H.R. 3763: The Corporate & Auditing Accountability, 2002).

    John H. Biggs, past Chairman and CEO of TIAA-CREF testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs on February 27, 2002. He indicated that the revolving-door phenomenon was one of several major threats to CPA firms‟ independence.

    Specifically, Mr. Briggs‟ cited as a threat to independence the existence of circumstances whereby the Chief Financial Officer, the Chief Accounting Officer, or any other financial manager is a former employee of the audit firm (Accounting and Investor Protection Issues,

    2002, p. 4). The Sarbanes-Oxley Act of 2005 shares this view. Mr. Biggs suggested that external audit firms should be rotated every five years. He believes this rule would eliminate the

     3 FEI is the leading advocate for the views of corporate financial management. FEI is reported to represent 15,000 CFO‟s, controllers, and treasurers worldwide.


    revolving door that allows former auditors to become the top financial officers of the audited company” (Accounting and Investor Protection Issues, 2002, p. 6).

    Other proponents of eliminating the revolving-door situation suggest that there may be a link between the revolving door phenomenon and noted recent corporate failures. Grimsley

    4(2002) reported in the Washington Post of February 19, 2002, that Enron hired its chief

    accounting officer from Arthur Andersenthe CPA firm used by Enron. In addition, Grimsley

    (2002) reported that Global Crossing, which filed for bankruptcy amid allegations of improper accounting, had hired its former Arthur Andersen engagement partner as its senior vice-president for finance. Situations such as these are not uncommon. A senior audit manager from PricewaterhouseCoopers solicited a job as chief financial officer of a subsidiary of MicroStrategy while conducting the annual audit of MicroStrategy (Grimsley, 2002). Hillebrand (2002) indicates that accounting firm partners now look for new jobs in industry with their audit clients when they reach their forties (Hillebrand, 2002).

    There are those who support the revolving-door phenomenon. James E. Copeland,

    5representing the American Institute of CPAs (AICPA), in his March 14, 2002 speech before the

    United States Senate Committee on Banking, Housing, and Urban Affairs indicated that any restrictions on this revolving-door phenomenon “would impose unwarranted costs on the public,

    the client, and the profession. Indeed, limiting the career opportunities of accountants would make the profession less attractive and make it more difficult for CPA firms to hire qualified people” (Accounting and Investor Protection, 2002, p. 2). He indicated that this would be

     4 According to its fact sheet, Enron was one of the world‟s leading energy commodities and services companies with 14,000 employees and revenues of $101 billion in year 2000. However, due to alleged accounting fraud, Enron failed for bankruptcy on December 2, 2001. 5 The AICPA is the premier national organization exclusively for CPAs. The AICPA promulgates rules and regulations that are to ensure that its 330,000 members, and the accounting profession at large, provide the investing public with quality accounting services. Members that violate the rules and/or the regulation of the AICPA can be sanctioned and/or expelled.


    especially true for small to mid-sized CPA firms and would likewise affect these firms‟ non-

    public clients accordingly.

    As indicated earlier, the Sarbanes-Oxley Act of 2002 now requires a one-year cooling-off period for public companies that employ their current CPA firms‟ former auditors in senior-level

    accounting positions. State boards of accountancy and other regulators are currently exploring whether a similar requirement is needed for non-SEC entities. This study explores this issue for non-public companies.



    The objective of this exploratory study was to investigate whether a cooling-off period would influence State Board of Public Accountancy Members‟ perceptions of CPA firms independence and whether the firm should be allowed to perform the audit when non-public companies are involved in the revolving-door phenomenon. The overall goal of this study was to provide a more complete understanding of the perceptions of members of state boards of public accountancy in regards to the impact that the revolving-door phenomenon had on CPA firms‟

    perceived independence. To guide the research process, the following research questions were formulated.

    RQ Does the presence of a cooling-off period affect state boards of accountancy 1

    members‟ perceptions of CPA firms‟ independence?

    RQ Does the length of the time period of the cooling-off period affect state boards of 2

    accountancy members‟ perceptions of CPA firms‟ independence?



    This study used a between-subject design. Three cases were developed with one version sent to each participant. Cases were different only as it related to the cooling-off period mentioned. Manipulation of the cooling-off period allowed the researchers to address the previously-mentioned research questions.


    This study used active members of The National Association of State Boards of

    6Accountancy (NASBA) as participants. NASBA is the membership organization of state boards of accountancy in all 50 states, the District of Columbia, Guam, Puerto Rico, and the U. S. Virgin Islands. NASBA provided names and addresses of 357 active board members. Past members of state boards of accountancy, usually referred to as associates, are allowed to remain members of NASBA for life. However, this study only used current members of state boards of accountancy. While a majority of active members are CPAs, public accountants and public members (non-CPAs) serve as state accountancy board members in many jurisdictions. More demographics on the population are provided later.

    Instrument, Variables and Pretesting

    Three versions of a case were developed for this study. The case involved a CPA firm, a former audit manager for that CPA firm and a non-public company. The audit manager of the CPA firm had finished the yearly audit of the non-public company, resigned his employment with the CPA firm and accepted employment as chief accounting officer (CAO) for the non-public company. The time frame of the case was manipulated whereby the audit manager (1) left the CPA firm and immediately became CAO for the non-public company; (2) left the CPA

     6 The National Association of State Boards of Accountancy is the national organization for which state boards of accountancy generally hold membership.

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