Auditor Litigation and the Market and Legal Penalties on Client Firms

• In Event: Public Interest

Abstract

We examine the relation between auditor litigation and the market and legal penalties imposed on sued audit clients. Using accounting-related securities lawsuits from the Stanford Securities Class Action Clearinghouse database over the period 1996 to 2005, we investigate whether litigation against the auditor is associated with investor reaction to securities lawsuit against client firms. We also examine the relation between litigation against the auditor and the outcome of the securities lawsuit against the client firm. We find a negative relation between auditor litigation and the 3-day cumulative abnormal returns around the announcement of litigation against the client firm. We also find that litigation against the auditor is associated with more adverse legal penalty on the client firm. Specifically, we report a higher likelihood of settlement and larger settlement sizes for securities lawsuits in which the auditor is also sued. Overall, our findings suggest that lawsuits against auditors appear to be a signal of audit failure and higher financial reporting risk.

Authors

• Nana Yamfo Amoah, Old Dominion University

• Isaac Bonaparte, Towson University

• Anthony Jerome Anderson, Howard University