Motivating factors in lawsuits against independent auditors: Experimental evidence on the importance of causality

Abstract

An explosion in auditors' litigation costs has led to debates regarding the behavior of litigants in lawsuits against independent auditors. One frequently voiced allegation is that plaintiff attorneys pursue cases which have little or no merit for the purpose of extracting settlements. A related issue, as yet unaddressed by empirical research, is the role of proximate cause in plaintiff attorneys' decisions to recommend third-party lawsuits against independent auditors for negligent misrepresentation. Our study examines the importance of proximate cause in plaintiff attorneys' preliminary assessments and recommendations regarding the initiation of litigation against auditors. Advanced law students, acting as surrogates for entrylevel law associates, made recommendations regarding a case in which a bank had suffered a loan loss and was considering filing suit against the debtor's auditor for alleged failure to disclose the debtor's going concern problem. Two factors were manipulated: 1) the degree of the bank's reliance on the independent auditor's work, and 2) the presence or absence of non-causal misstatements in the financial statements. Factor (1) affects proximate cause whereas factor (2) does not. The results were generally consistent with proximate cause being less important in the initiation of lawsuits than principles of tort law suggest it should be. Despite recognition by most subjects in the low reliance condition that the suit lacked sufficient merit to be actionable under the principles of tort law, most recommended filing suit. Further, most of these subjects did so with the express intent of pursuing a settlement only. Moreover, subjects in the low reliance condition whose cases contained non-causal misstatements, assessed both higher settlement likelihoods and values than subjects in the same condition whose cases did not contain such misstatements.