Comparing Auditor versus Non-Auditor Assessments of Auditor Liability: An Experimental Investigation of Experts' versus Lay Evaluators' Judgments

Abstract

SUMMARY Critics of the legal system argue that the use of lay jurors to adjudicate auditor negligence claims results in non-meritorious decisions of auditor liability. Palmrose (2006) therefore proposes that the courts rely on panels of experienced auditors to evaluate the merits of auditor negligence claims and make recommendations to the courts. There is, however, scant evidence to indicate how auditors' and lay evaluators' judgments might differ in cases of alleged auditor negligence. Our study addresses this gap in the literature by providing theory and empirical evidence that elucidates several systematic differences between auditors' and lay evaluators' judgments. Results of an experiment indicate that auditor evaluators are less reliant on plaintiff losses as evidence than lay evaluators, but—consistent with social identity theory—experience greater empathy for auditor defendants. Consequently, auditor evaluators consistently provide lower assessments of auditor liability than lay evaluators, irrespective of audit quality. In addition, results of the experiment indicate that different legally irrelevant inputs primarily determine both auditor and lay evaluators' negligence verdicts—emotional reactions for auditor evaluators and plaintiff losses for lay evaluators. Finally, results are mixed as to whether auditor evaluators' judgments are more sensitive to varying levels of audit quality than lay evaluators' judgments.

Do Auditors Accurately Predict Litigation and Reputation Consequences of Inaccurate Accounting Estimates?

“…Prior accounting research on the “expectation gap” suggests that auditors and external parties often have differing beliefs about auditors' responsibilities (McEnroe and Martens 2001) and evaluate auditors differently in the event of negative outcomes (Kinney and Nelson 1996). Specifically, studies on the expectation gap document that when negative outcomes occur, external parties including investors (McEnroe and Martens 2001), jurors (Lowe and Reckers 1994), judges (Lowe 1994), General Accounting Office personnel (Kinney and Nelson 1996), the general public (Reffett et al 2012; ACCA 2019), and PCAOB inspectors (Glover et al 2019) tend to judge auditors more harshly than auditors judge themselves. Research also indicates that the media play an important role in how external parties' consume accounting information (Drake et al 2014), and this may exacerbate the expectation gap, making it difficult to overcome (Cohen et al 2017).…”

Key audit matter and auditor liability: evidence from auditor evaluators in Thailand

“…With this limitation, Palmrose (2006) proposed the use of an experienced auditor as the evaluator in the case of auditor negligence. Reffett et al (2012) later stated that an auditor evaluator's judgments significantly differ from a lay evaluator's judgments in cases of alleged auditor negligence. The Thai legal environment allows this study to investigate how evaluators with audit experience evaluate auditor liability.…”

The Role of Key Audit Matters in Assessing Auditor Liability: Evidence from Auditor and Non-auditor Evaluators

“…For both experiments, the dependent variable, interest, served as the assessment for the auditor's liability. Prior studies (Kadous, 2000;Reffett et al, 2012) had measured auditor liability in two ways: 1) the likelihood of auditor negligence, and 2) monetary damages compensating for plaintiff losses. Other studies (Grenier, Pomeroy, & Stern, 2015;Brasel et al, 2016;Brown et al, 2014, Backof et al, 2014Kachelmeier et al, 2014) have measured auditor liability only by the negligence judgment.…”

“…With this perceived limitation of lay evaluators, Palmrose (2006) proposed that experienced auditors be used as evaluators in the case of auditor negligence. Reffett, Brewster and Ballou (2012) later mentioned that the judgment made by experienced auditors differ significantly from that made by lay evaluators in cases of alleged auditor negligence.…”