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

Abstract

We analyze whether and how the perceived federal-level legal liability linked to federal judge ideology is associated with the likelihood of firms receiving going-concern modified audit opinions and analyze the differential effects on Big Four and non-Big Four auditors. We find that Big Four and non-Big Four auditors converge in their going-concern reporting decisions in circuits with more liberal judges. This convergence is caused by the greater effect of judge ideology on non-Big Four auditors. Furthermore, we empirically examine the association between federal judge ideology and actual lawsuits against auditors, and find that judge ideology has a greater impact on lawsuit likelihood for non-Big Four auditors for the restating companies. When auditors are sued, both the payout likelihood and amount are greater in circuits with more liberal judges, with the effect being more pronounced for non-Big Four auditors. This study provides evidence on how the perceived exposure to a gross negligence legal standard shapes auditors’ going-concern reporting incentives for the two tiers of auditors in the market. It also adds to the literature on auditor litigation.

Keywords: Federal Judge Ideology, Federal Litigation Risk, Going Concern Modified Audit Opinions, Big 4 and Non-Big 4

JEL Classification: G39, M40, M42