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

Purpose This study aims to investigate the effects of the alternating roles of audit firms on audit quality. Specifically, the paper examines whether appointing a previous external (internal) audit firm as an incumbent internal (external) audit firm impacts audit quality. This paper analyzes the economic bonding and knowledge spillover hypotheses associated with these role transitions. Design/methodology/approach Drawing on a data set of 1,092 firm-year observations of Omani firms from 2005 to 2020, the authoes use a more robust research design to demonstrate this effect. Specifically, they use difference-in-differences, propensity score matching and fixed effects models to examine the developed hypotheses. Findings The 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. The authors control for variables such as outsourced internal audit functions, alternative measures for discretionary accruals and endogeneity. Importantly, our main results withstand these supplementary tests. They also uncover the influence of audit committee quality and audit firm type on auditor role switching outcomes. Additionally, they 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/value This study contributes novel theoretical and practical insights by expanding the scholarly discourse in uncharted directions.