How Do Previously-Imposed Regulatory Penalties Influence Jurors’ Judgments of Auditor Liability?

• In Event: Behavioral Audit Research

Abstract

This study examines how the PCAOB’s use of disciplinary orders influences auditors’ civil liability in subsequent litigation. Unlike PCAOB inspection reports, disciplinary orders are publicly available and identify both specific audit clients and individual auditors, thereby providing relevant information that can be used in litigation when the order relates to the audit in which negligence is alleged. We find that larger previously-imposed PCAOB fines lead to more negligent verdicts than smaller fines, and that this effect operates through lower assessments of audit quality when the auditor provides a qualified rather than affirmative acknowledgment of the PCAOB’s findings in the order. However, larger fines lead to lower overall compensatory damages for the plaintiff than smaller fines. The effect of fine size on damage awards also operates through assessments of audit quality. However, in contrast to the relationship between fine size and verdicts, the mediating effect of fine size through audit quality on damage awards exists when auditors offer affirmative, rather than qualified, acknowledgment of the PCAOB’s findings. Specifically, the joint effect of fine size and acknowledgment leads jurors to evaluate audit quality more favorably, and thus reduce damage awards. Our findings suggest that while larger regulatory fines increase the likelihood of negligent verdicts in subsequent litigation, they also reduce the corresponding compensatory damages awards when the auditor fully admits to the related findings prior to the trial. Thus, the interaction of monetary fines with other components of PCAOB disciplinary orders may have unintended consequences for auditor accountability.

Authors

• Brian Matthew Goodson, University of Cincinnati

• Sean Dennis, University of Kentucky

• Kathryn Kadous, Emory University