Legal Intensity of Financial Reporting and Audit Quality

• In Event: Auditor Expertise and Style

Abstract

This study examines the association between the legal intensity of firms’ financial reporting and audit quality. We define a firm’s legal intensity as the number of legal documents underlying its financial reports, which would need to be interpreted to determine appropriate accounting treatments. We predict that, due to lack of auditors’ legal expertise and/or imperfect communication between firm’s lawyers and auditors, audit quality is negatively associated with legal intensity. We develop a legal intensity measure using legal-related tags in firms’ 10-K XBRL filings. Our results are consistent with our prediction. The negative association is mitigated by the extent of legal expertise within the client firm and is heightened for clients with higher proprietary costs. Further analyses suggest that legal intensity increases audit lag, audit fees, and non-timely 10-K filings.

Authors

• Jagan Krishnan, Temple University

• Jayanthi Krishnan, Temple University

• Mengtian Li, Brock University

• Yi Liang, Temple University