Litigation Risk and Auditor Resignations

The Accounting Review, Vol 72, No 4, October 1997

Posted: 8 Oct 1997

See all articles by Jagan Krishnan

Jagan Krishnan

Temple University - Department of Accounting

Jayanthi Krishnan

Temple University - Department of Accounting

Abstract

Litigation against auditors has increased dramatically in recent years. Auditors can offset litigation risk in a number of ways, including improved audit quality and planning, increases in audit fees and increases in the issuance of modified opinions. Auditors can also adjust their client portfolios by becoming more selective in their choice of new clients and by withdrawing from high-risk engagements. We test the hypothesis that litigation risk motivates auditor resignations by comparing resignation companies with two groups of client companies that dismissed their auditors: one matched with the resignation companies on industry and year, and the other matched on year alone. We find resignation companies differ from dismissal companies along dimensions that capture the probability of litigation: financial distress, variance of abnormal returns, auditor independence, tenure and a modified (particularly going-concern) opinion. We also construct a litigation proxy based on a prior litigation-prediction model and find that the proxy is positively associated with the probability that the auditor will resign rather than be dismissed from the engagement. Our analysis is consistent with concerns expressed by the accounting profession that litigation pressures lead to the withdrawal of audit services for a segment of the market.

JEL Classification: L84, M49, K22

Suggested Citation

Krishnan, Jagan and Krishnan, Jayanthi, Litigation Risk and Auditor Resignations. The Accounting Review, Vol 72, No 4, October 1997, Available at SSRN: https://ssrn.com/abstract=35959

Jagan Krishnan (Contact Author)

Temple University - Department of Accounting ( email )

Fox School of Business & Management
1801 Liacorous Walk
Philadelphia, PA 19122
United States
215-204-8126 (Phone)
215-204-5587 (Fax)

Jayanthi Krishnan

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States
215-204-3085 (Phone)

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