An Analysis of Auditor Liability Rules

Abstract

This paper models auditor litigation brought under Section 10(b) of Securities Exchange Act 1934 and Rule lOb-5. It considers audit quality under the current and liability regime and the proposed liability regime. This issue is relevant because the U.S. Congress is considering legislation which would provide relief to accountants from the joint and several liability rule.1 Although experts have testified before the Senate that moving to proportionate liability would reduce audit quality, I show that doing so may actually increase audit quality. The reason is that under the proportionate liability regime the auditor's litigation cost is more sensitive to his effort than it is under the joint and several liability regime. There always exist rules of apportioning liability between the auditor and the company that ensure higher audit quality under proportionate liability than under joint