Is Auditing Litigation Frivolous?*

Abstract

This article analyzes the strategic interactions between an auditor and an investor with different levels of damages in an auditing litigation game and examines the frivolity of auditing litigation. We show that a separating equilibrium exists, which makes the auditor distinguish each investor's type from the settlement offer. Consequently, the claim of frivolous litigation is not consistent with the separating equilibrium. By contrast, frivolous litigation may take place when the settlement is exogenous. Our analyses shed light on several policy issues relating to the reduction of frivolous suits against auditors. First, there is no need for the court to intervene in the settlement negotiations in the pretrial stage. Yet, the mechanism for exchanging and sharing of information when a legal complaint is filed is essential. Second, the AAA and AICPA should join the Lawsuit Abuse Reform Coalition that works for enactment of a new law that punishes the plaintiff's attorney who files a merit-less claim. Third, the accounting and auditing profession should express its attitude on two competing legal means for the shift of legal cost: the Rule 68 of the Federal Rules of Civil Procedures or the Frivolous Lawsuit Reduction Act.