Federal Judge Ideology and the Going Concern Reporting Incentives of Big 4 and Non-Big 4 Auditors

Abstract

We analyze how variation in federal level legal liability associated with judge ideology is associated with the likelihood of firms receiving going-concern modified audit opinions, separately for Big Four and non-Big Four clients. With auditors trading off between Type I and Type II reporting errors, the threshold value (of client bankruptcy probability) above which auditors issue going-concern reports is decreasing and convex in the level of federal litigation risk. Building on literature showing that federal judge ideology affects the likelihood and outcome of lawsuits, we find that Big Four and non-Big Four auditors converge in their going-concern reporting decisions as federal litigation risk increases and that this convergence is caused by the greater effect of judge ideology on non-Big Four than on Big Four auditors. The key results remain with firm-fixed effects and are not driven by the effects of judge ideology on auditor choice or bankruptcy probability.