The Effects of the Extant Clauses Limiting Auditor Liability on Audit Fees and Overall Reporting Quality

Abstract

Regulators and shareholders generally oppose any restriction on clients’ rights to sue their auditors, believing that such restrictions would impair reporting quality. However, the evidence suggests that the opposition to limitation of liability agreements (LLAs) between clients and auditors is likely unwarranted. Specifically, the evidence indicates that LLAs are beneficial to clients by lowering their audit fees. More importantly, we find no evidence that they impair financial reporting quality in general. Hence, the extant contracts limiting clients’ rights to sue their auditors appear to benefit auditors and their clients without any apparent detriment to the quality of financial reporting.

Keywords: Auditor liability; liability limiting agreement; audit quality; reporting quality

JEL Classification: M42, K22, K41