Auditor Litigation: Consequences for Other Auditors

• In Event: Restatements

Abstract

Litigation poses a significant business risk for auditors, and prior evidence is consistent with
auditors learning from their own litigation events and adjusting audit procedures to mitigate
emerging risk exposures (Lennox and Li 2014). We argue that auditors also learn from other
auditors’ litigation events and examine the consequences of such events for future accounting
misstatements. Using a hand-collected sample of auditor litigation events, we find a significant
subsequent decrease in misstatement frequency in within-industry audits conducted by auditors
who did not face litigation. This industry-based across-auditor learning effect is a) intensified
when the litigation signal is stronger; b) is associated with an audit-fee increase; and c) is robust
to a battery of controls including the use of a difference-in-difference approach. No evidence is
found for region-based across-auditor learning. Our findings are consistent with auditor litigation
having a deterrence effect on other audit firms.

Authors

• Sean Cao, Georgia State University

• Yangyang Fan, University of Pittsburgh

• Ganapathi S Narayanamoorthy, University of Illinois-Urbana-Champaign

• Stephen Rowe, Tulane University