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    State Liability Regimes within the United States and Auditor...
    research summary posted February 16, 2017 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 09.0 Auditor Judgment, 09.04 Going Concern Decisions 
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    Title:
    State Liability Regimes within the United States and Auditor Reporting
    Practical Implications:

    These results imply that auditors are more likely to render modified GC opinions for clients subject to regimes that hold auditors liable to a larger class of third parties and impose joint-and-several liability for third-party damages, both of which reflect greater liability exposure. The higher incidence of GC opinions accompanying stronger state-level litigation threats could reflect higher audit quality, but it could also stem from excessively conservative auditors protecting their interests by avoiding costly civil lawsuits, which could undermine audit quality in some circumstances. 

    Citation:

    Anantharaman, D., J. A. Pittman, and N. Wans. 2016. State Liability Regimes within the United States and Auditor Reporting. The Accounting Review 91 (6): 1545 – 1575.

    Keywords:
    auditor litigation risk, state common law, and going-concern opinions
    Purpose of the Study:

    The authors of this study analyze the relation between state regimes governing auditor liability and auditors’ propensity to modify their opinion to express uncertainty on financially distressed clients’ ability to continue as a going concern.  Extant research implies that auditors have strong incentives to conduct high-quality audits in order to reduce the litigation examining consequences stemming from an alleged audit failure; however, the bulk of this research focuses on auditor liability arising under federal statutory laws, not state laws. This study delves into the issue of state laws, including if and to what extent litigation exposure under state common law affects auditors’ reporting decisions. 

    Design/Method/ Approach:

    A previous study developed a state-level score that captures third-party liability standards, which the authors of this study rely on to measure auditor litigation exposure stemming from third-party liability standards. To evaluate variation in liability-sharing standards across states, the authors closely read the relevant law to construct a state-level index that identifies whether each state follows a joint-and-several approach or a proportional approach to liability sharing. The authors assign to each client firm the highest of the liability indices dependent on the states in which the firm does business, and they measure audit outcomes with the propensity to issue going-concern (GC) opinions to financially distressed clients. 

    Findings:
    • The authors find that auditors are significantly more likely to issue a GC opinion to clients from states applying:
      • A more expansive third-party liability standard, or
      • The joint-and-several liability (JSL) rule for apportioning damages among defendants.
    • The authors find that liability regimes primarily affect auditor reporting for clients that are inherently more likely to be sued, reinforcing the conclusion that state-level liability regimes matter more when litigation exposure is higher.
    • The authors find some suggestive evidence that the higher expected legal costs arising from state-level liability regimes have a stronger impact on Big 4 auditors that are more sensitive to litigation threats. 
    Category:
    Auditor Judgment, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Going Concern Decisions, Litigation Risk