Independence Threats, Litigation Risk, and the Auditor's Decision Process*

Abstract

This study examines the effect of independence threats and litigation risk on auditors' evaluation of information and subsequent reporting choices. Using a Web‐based experiment, I tracked auditors' information gathering and evaluation leading to a going‐concern reporting decision. Specifically, 48 audit managers assessed client survival likelihood, gathered additional information, and suggested audit report choices. I found that auditors facing high independence threats (fear of losing the client) evaluated information as more indicative of a surviving client and were more likely to suggest an unmodified audit report, consistent with client preferences. In contrast, auditors facing high litigation risk evaluated information as more indicative of a failing client and were more likely to suggest a modified audit report. In addition, the association between risk and report choice was fully mediated by final information evaluation. This suggests that it is unlikely that different reporting choices resulted from a conscious choice bias, but rather that motivated reasoning during evidence evaluation plays a key role in the effect of risk in auditor decision making.

A Model and Literature Review of Professional Skepticism in Auditing

“…Numerous other studies provide additional evidence that auditors' incentives affect judgments about appropriate accounting treatment and/or appropriate audit opinion. Particular incentives examined include need to maintain office profitability (e.g., Trompeter 1994), client fee pressure (e.g., Gramling 1999; Houston 1999), client preference (Haynes et al 1998), fear of client loss (Farmer et al 1987;Blay 2005), and potential litigation exposure (e.g., Farmer et al 1987;Hackenbrack and Nelson 1996;Braun 2001;Blay 2005).…”

Auditor Independence and Audit Quality

“…If the client constitutes a relatively large part of an auditor's portfolio, an auditor has an incentive to retain the client to warrant a future source of revenues and profits and therefore, to compromise independence and act in favor of the client (Blay, 2005).…”

The Causes and Economic Consequences of Patent Litigation

“…Auditors tend to be more responsive to the risk of litigation when it conflicts with incentives to seek profits (Tucker et al, 2003;Blay, 2005) 9 and previous researchers have reported that auditors should consider the risk of litigation in their opinion decisions (Blay, 2005;Cahan and Zhang, 2006;Elder et al, 2009). A number of 7 For more laws and regulations on the Matters Required to be Included in the Corporate Bylaws of Credit Rating Agencies, see the web site http://law.fsc.gov.tw.…”