Accounting Misstatements Following Lawsuits Against Auditors

Abstract

This study investigates whether financial reporting quality is affected by an auditor’s experience of litigation in the recent past. We find that the likelihood of an accounting misstatement and the magnitudes of misstatements are significantly lower for non-Big 4 auditors who recently suffered high litigation compared with non-Big 4 auditors who did not. In addition, we find an improvement in financial reporting quality subsequent to the recent litigation experiences of Big 4 offices. These results are consistent with our prediction that auditors learn from their past experiences of litigation and that this leads to higher financial reporting quality.