Auditor Legal Liability and Stock Price Crash Risk: Evidence from Organizational Transformation of Chinese Audit Firms

49 Pages Posted: 11 Aug 2021 Last revised: 27 Sep 2021

See all articles by Jian Chu

Jian Chu

Nanjing University - School of Business

Chia-Hsiang Weng

National Chengchi University (NCCU) - Department of Accounting

Date Written: May 1, 2021

Abstract

We utilize Chinese audit firms' organizational transformation to identify the increase in auditors’ legal liability and find that after auditors transform into limited liability partnerships (LLPs), their clients demonstrate lower future stock price crash risk. Using the path analysis, we find that accounting conservatism, optimism in management earnings forecasts, and optimism in management discussion and analysis (MD&A) disclosures explain the negative relationship between auditor legal liability and client crash risk. The results are less pronounced for auditors finishing the transformation in an early stage than for auditors subject to the mandatory transformation in 2013, as the former generally has a larger size and higher audit quality before the transformation. Overall, this study complements the existing literature on litigation risk and the auditor’s monitoring role in the client information environment.

Keywords: auditor litigation risk, auditor organizational transformation, stock price crash risk, accounting conservatism, management earnings forecasts, MD&A

JEL Classification: G14, M42, M48

Suggested Citation

Chu, Jian and Weng, Chia-Hsiang, Auditor Legal Liability and Stock Price Crash Risk: Evidence from Organizational Transformation of Chinese Audit Firms (May 1, 2021). International Journal of Accounting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3893732 or http://dx.doi.org/10.2139/ssrn.3893732

Jian Chu

Nanjing University - School of Business ( email )

22 Hankou Road
Nanjing, Jiangsu 210093 210093
China

Chia-Hsiang Weng (Contact Author)

National Chengchi University (NCCU) - Department of Accounting ( email )

No. 64, Sec 2
Chih-Nan Road
Wenshan, Taipei
Taiwan

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