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Auditor Liability and Client Acceptance Decisions

41 Pages Posted: 2 Apr 2008 Last revised: 17 May 2009

Volker Laux

University of Texas at Austin - McCombs School of Business

Paul Newman

University of Texas at Austin - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: March 11, 2009

Abstract

The accounting profession has raised concerns that excessive liability exposure renders audit firms unwilling to provide audit services to risky clients, limiting the prospective clients' ability to raise external capital. In this paper we address this concern in a model where the auditor evaluates the riskiness of the client before accepting the client engagement. We consider a setting where a shift to stricter legal liability regimes not only increases the expected damage payments from the auditor to investors in case of audit failure but also increases litigation frictions such as attorneys' fees. The main finding is that the relationship between the strictness of the legal regime and the probability of client rejection is U-shaped. Our model suggests that in environments with moderate legal liability regimes the client rejection rate is lower than in environments with relatively strong or relatively weak legal regimes.

Keywords: Auditor Liability, Client Acceptance Decisions

JEL Classification: M49, K22

Suggested Citation

Laux, Volker and Newman, Paul, Auditor Liability and Client Acceptance Decisions (March 11, 2009). Available at SSRN: https://ssrn.com/abstract=1115520 or http://dx.doi.org/10.2139/ssrn.1115520

Volker Laux (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

Donald Paul Newman

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States

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