Big 4 Auditors, Litigation Risk, and Disclosure Tone

46 Pages Posted: 14 Jul 2017 Last revised: 5 May 2020

See all articles by Keith Czerney

Keith Czerney

University of Missouri-Columbia

Ling Lei Lisic

Virginia Polytechnic Institute & State University - Pamplin College of Business

Biyu Wu

University of Nebraska at Lincoln - School of Accountancy

Ivy Zhang

University of California, Riverside

Date Written: May 31, 2017

Abstract

We examine the effect of Big 4 auditors on management’s use of optimistic language in audited financial statement disclosures. While regulators and practitioners consider the audit of disclosures to be increasingly important, empirical evidence of an auditor’s effect on management’s qualitative disclosure choices is limited. Focusing on the notes to the financial statements, which are the primary disclosure item subject to audit, we find that the tone of the qualitative footnote disclosures is significantly more reflective of bad economic news in the presence of a Big 4 auditor compared with a non-Big 4 auditor. This Big 4 effect on footnote disclosure tone is more pronounced for the sub-sample of firms with high litigation risk and continues to hold for a matched sample constructed using entropy balancing to control for inherent differences between clients of Big 4 and non-Big 4 auditors. Finally, when we examine Management’s Discussion and Analysis, which is not subject to audit, we do not find a Big 4 effect on the sensitivity of its tone to bad news. Our results are consistent with higher litigation exposure motivating Big 4 auditors to constrain management’s use of optimistic language while auditing financial reports. This research provides new evidence to the ongoing regulatory discussions regarding the value of auditing disclosures.

Keywords: Big 4 audit, Tone, Disclosure, Footnotes, Litigation risk

JEL Classification: M40, M41, M42

Suggested Citation

Czerney, Keith and Lisic, Ling Lei and Wu, Biyu and Zhang, Ivy, Big 4 Auditors, Litigation Risk, and Disclosure Tone (May 31, 2017). Available at SSRN: https://ssrn.com/abstract=3002548 or http://dx.doi.org/10.2139/ssrn.3002548

Keith Czerney (Contact Author)

University of Missouri-Columbia ( email )

College of Business
Columbia, MO 65211
United States

Ling Lei Lisic

Virginia Polytechnic Institute & State University - Pamplin College of Business ( email )

3007 Pamplin Hall
Blacksburg, VA 24061
United States

Biyu Wu

University of Nebraska at Lincoln - School of Accountancy ( email )

Lincoln, NE 68588
United States

Ivy Zhang

University of California, Riverside ( email )

900 University Ave
Riverside, CA 92521
United States

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