Litigation risk and auditor resignations

Article Abstract:

Auditors can control their risk of litigation by resigning from high litigation-risk engagements. A study was conducted to determine if auditors are compelled by high litigation-risk engagements to resign or decline an offer for reelection. To test this hypothesis, resignation companies were compared to two groups of client companies where auditors were terminated. Findings revealed differences between resignation companies and dismissal companies in terms of variables reflective of litigation probability, such as financial distress, auditor independence, tenure, modified opinion, and variance of abnormal returns. A litigation proxy was designed after a prior litigation-prediction model. A positive relationship was found between the proxy and the probability that the auditor will withdraw instead of being dismissed.

Research, Risk management, Employee resignations

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Low balling, legal liability and auditor independence

Article Abstract:

An analysis, which was based on a dynamic multi-agent moral hazard model, examined low balling, auditors' legal liability and auditor independence. In this framework, low balling is presented as a facilitator of the link between auditors and owners instead of between auditors and managers. In combination with the auditors' legal liability, a low balling compensation plan provides an efficient dynamic contracting mechanism for hierarchical agency. Specifically, low balling acts as a replacement for legal liabilities for the preservation of auditor independence. Like legal liability, low balling serves to discourage undesirable auditor behavior at a minimal cost. It can cut the transaction cost related to the audit contract while enhancing auditor independence.

Analysis, Compensation and benefits, Prevention, Professional fees

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