The Impact of Legal Liability Regimes and Differential Client Risk on Client Acceptance, Audit Pricing, and Audit Effort Decisions

Abstract

This study uses experimental methods to examine client acceptance, auditor pricing and effort decisions for clients of varying risk under two legal rules, joint and several liability, and proportionate liability. We predict greater availability of audit services for high-risk clients, lower audit prices, and lower audit effort under proportionate liability relative to joint and several liability. Our experimental evidence does not strongly support predicted prices due to underpricing behavior, but prices do reflect risk differences across client groups for both liability regimes. The results also exhibit some support for the predictions that auditors select low effort for the lowest-risk clients, and a lower effort level under proportionate liability relative to joint and several liability for moderate risk clients. As predicted for the highest-risk clients, high effort is selected under proportionate liability, and there is some evidence of a substantial reduction in contracting under joint and several liability.

Keywords: Audit risk, Audit Pricing, Legal Liability

JEL Classification: M41, M42