Litigation Risk and Abnormal Accruals

Boone, Jeffery Paul; Khurana, Inder K.; Raman, K. K.

doi:10.2308/ajpt-50003

Cited by 25 publications

(7 citation statements)

References 48 publications

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“…Our hypotheses predict financial report readability both impacting and being impacted by audit fees, which suggests potential endogeneity and hence OLS-driven bias (Greene, 2003, p. 379). To control for endogeneity, we adopt Boone et al 's (2011) system of simultaneous equations approach. Models (1) and (2) below describe the hypothesized relationships between audit fees and financial report readability: where:…”

Section: Methodsmentioning

confidence: 99%

Financial report readability and audit fees: a simultaneous equation approach

Xu¹,

Fernando

Tam

et al. 2019

MAJ

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Purpose This paper aims to investigate whether audit fees and financial report readability are bi-directionally related. Design/methodology/approach The authors test their hypotheses with empirical data. Specifically, they adopt a two-stage simultaneous equation regression model to assess the bi-directional relationship between audit fees and financial report readability. Findings While poor readability increases the fees charged by the auditor, higher audit fees improve the readability of the financial reports. Research limitations/implications This study is based on US data. Future research may extend this study to other countries. Practical implications Poor financial report readability encumbers stakeholders of the firms. Understanding the interaction between financial report readability and audit fees will help both auditors and firm managers. Social implications Audit committees aggressively negotiating for lower audit fees should be aware of the link of low audit fees, potentially indicative of poor quality, to less readable reports. Investors and regulators too should be concerned about this relationship, especially in instances when auditors low-ball audit fees or when firms aggressively negotiate for lower audit fees. Originality/value To the best of authors’ knowledge, this study is the first to document the bi-directional relationship between financial report readability and audit fees and assess the positive impact of audit fees on financial report readability.

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Section: Methodsmentioning

confidence: 99%

Financial report readability and audit fees: a simultaneous equation approach

Xu¹,

Fernando

Tam

et al. 2019

MAJ

View full text Add to dashboard Cite

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“…Existing studies show that increased audit work can constrain managers' earnings management incentives (Frankel, Johnson & Nelson, ; Ashbaugh, LaFond & Mayhew, ). Most litigation against auditors involves allegations that clients have artificially inflated earnings or assets (Lys & Watts, ; Heninger, ; Boone, Khurana & Raman, ). Given the substantial direct and indirect costs of potential litigation (i.e., settlements costs, damage to reputation, and opportunity costs in terms of time away from more productive efforts), the higher the risk of litigation, the greater the auditor's restraining influence on earnings management in an attempt to avoid future litigation.…”

Section: Hypotheses Developmentmentioning

confidence: 99%

Auditor Conservatism and Banks' Measurement Uncertainty during the Financial Crisis

Chen

Lam

Smieliauskas

et al. 2015

International Journal of Auditing

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During the most recent financial crisis, the economic difficulties, along with potentially high uncertainties associated with fair value estimates, increased the audit risks for bank auditors. We analyze a sample of US public banks during the crisis (2008-09) and after the crisis (2010-11), and provide contrasting evidence concerning auditors' role in conservative financial reporting (proxied by higher discretionary loan loss provisions). Specifically, we document a significant positive association between discretionary loan loss provisions and the role of auditors (proxied by higher amounts of audit fees and abnormal audit fees) during the crisis. However, the positive association disappears following the financial crisis. Similarly, we document that during the crisis, auditors are less likely to issue unmodified audit opinions to banks that subsequently filed for bankruptcy. Thus, our evidence is consistent with elevated auditor conservatism for the sample banks during the financial crisis. Our evidence also suggests that bank auditors raise fees more to maintain accounting quality than to price protect from aggressive accounting choices.

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“…Similarly, Boone et al. () report that client‐specific auditor litigation risk is negatively associated with abnormal accruals, suggesting an auditor litigation avoidance effect. High‐quality auditors have greater incentives to maintain their reputation because they have ‘deep pockets’ (DeAngelo ; Palmrose ); this leads Big N auditors to be more sensitive to litigation risk, resulting in higher audit quality and audit fees.…”

Section: Hypotheses Developmentmentioning

confidence: 97%

The Effect of Litigation Risk Increase on Big N Auditor Exits and Audit Quality in the Korean Savings Banking Industry

Jung

Kim

2018

Australian Accounting Review

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This study investigates whether an increase in litigation risk results in Big N auditors leaving the industry and examines the impact of this increase on audit quality. Using a sample of Korean savings banks from 2009 to 2015, the study finds that the proportion of Big N auditors sharply decreases after a savings bank crisis, suggesting that Big N auditors are likely to reject riskier clients, while audit quality is unchanged. The results provide new evidence that an increase in litigation risk does not necessarily increase audit quality. The findings have academic and practical implications, as they suggest that policies for improving audit quality should consider auditors’ strategies in response to litigation risk.

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Litigation Risk and Abnormal Accruals

Cited by 25 publications

References 48 publications

Financial report readability and audit fees: a simultaneous equation approach

Financial report readability and audit fees: a simultaneous equation approach

Auditor Conservatism and Banks' Measurement Uncertainty during the Financial Crisis

The Effect of Litigation Risk Increase on Big N Auditor Exits and Audit Quality in the Korean Savings Banking Industry

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