Auditor Performance, Implicit Guarantees, and the Valuation of Legal Liability
Miles B. Gietzmann
City University London - Sir John Cass Business School
BARBICAN Asset Management; London School of Economics & Political Science (LSE) - Financial Markets Group
Michael J.P. Selby
affiliation not provided to SSRN
August 29, 2003
International Journal of Auditing, Vol. 1, Issue 1, pp. 13-29, 2003
Liability exposure is now such a major concern for auditors that any discussion of equilibrium audit fee structures needs to take account of the expected costs of liability exposure. We develop a model of audit litigation risk and then proceed to apply insights gained from the application of finance theory to show how liability exposure is related to guarantee provision. Given auditors wish to incorporate the expected cost of guarantees when planning and pricing services, we apply contingent claims analysis to derive valuation equations for expected (litigation) costs. We then proceed to consider wider regulatory issues. Whereas the above analysis assumes stable legal liability rules, we subsequently consider the auditor incentive effects of parametric variation in the rules. Since the quality of audits is unobservable, we consider how the rules could be set so as to ensure auditors are not tempted to provide a low degree of care and collude with management. To illustrate the applicability of this approach we also consider whether recent proposals to reform auditor liability to a proportional basis will always provide appropriate incentives.
Number of Pages in PDF File: 17
Keywords: contingent claims, auditor liabilityAccepted Paper Series
Date posted: December 19, 2010
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo1 in 0.657 seconds