Auditor Performance, Implicit Guarantees, and the Valuation of Legal Liability

17 Pages Posted: 19 Dec 2010

See all articles by Miles B. Gietzmann

Miles B. Gietzmann

Bocconi University - Department of Accounting

Mthuli Ncube

BARBICAN Asset Management; London School of Economics & Political Science (LSE) - Financial Markets Group

Michael J.P. Selby

affiliation not provided to SSRN

Date Written: August 29, 2003

Abstract

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.

Keywords: contingent claims, auditor liability

Suggested Citation

Gietzmann, Miles B. and Ncube, Mthuli and Selby, Michael J.P., Auditor Performance, Implicit Guarantees, and the Valuation of Legal Liability (August 29, 2003). International Journal of Auditing, Vol. 1, Issue 1, pp. 13-29, 2003, Available at SSRN: https://ssrn.com/abstract=1727111 or http://dx.doi.org/10.1111/1099-1123.00010

Miles B. Gietzmann (Contact Author)

Bocconi University - Department of Accounting ( email )

Via Roentgen 1
Milan, 20136
Italy

Mthuli Ncube

BARBICAN Asset Management ( email )

London School of Economics & Political Science (LSE) - Financial Markets Group

Houghton Street
London WC2A 2AE
United Kingdom

Michael J.P. Selby

affiliation not provided to SSRN

No Address Available

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