Do PCAOB Inspection Findings Increase Audit Firms’ Litigation Exposure?

• In Event: PCAOB Inspections

Abstract

We examine whether audit firm exposure to regulatory intervention in the form of PCAOB inspection deficiencies influences auditors’ litigation risk. We find that negative PCAOB inspection reports are positively associated with the number of subsequent lawsuits faced by the inspected audit firm. Further, negative inspection reports are positively associated with litigation settlement amounts. We find consistent results in a changes analysis, in Big 4 and non-Big 4 firm subsamples, and in a sample of restated and sued Big 4 clients in which we arguably hold audit and financial reporting quality constant. Our results suggest that PCAOB inspections have introduced a new source of litigation risk. Further, given the relatively consistent level of PCAOB deficiencies even among higher-quality firms, it is unclear whether auditors can reduce this new source of litigation risk through the traditional means of increasing audit quality and managing client portfolios.

Authors

• Nathan Lundstrom, University of Missouri-Columbia

• Nathan Newton, Florida State University

• Brant Erich Christensen, University of Missouri-Columbia