Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

40 Pages Posted: 17 Jan 2005

See all articles by Gary F. Peters

Gary F. Peters

University of Arkansas at Fayetteville

Susan Parker

Santa Clara University

Lawrence J. Abbott

University of Memphis

Date Written: June 2004

Abstract

This study empirically examines the asymmetric association between the auditor's assessment of litigation risk and earnings management, using publicly available fee data. Following the experimental work of Barron et al. (2001), we document decreases (increases) in audit fees with clients' risk of managing earnings downward (upward). We also find that the positive fee association is greater for clients facing greater litigation risk resulting from negative earnings surprises. We test our hypotheses with a sample of 429 public, non-regulated, Big 5-audited companies, using fee data for the year 2000. We interpret these findings as consistent with auditors' assessments of decreased (increased) litigation risk imposed by conservative (aggressive) clients. This interpretation is consistent with the positive relation between accruals and auditor litigation (Heninger 2001; Lys and Watts 1994), the relation between restatement and larger accruals (Richardson et. al 2003) and the relation between restatements and auditor litigation (Palmrose and Scholz 2000).

Keywords: discretionary accruals, conservative reporting, audit fees

JEL Classification: M41

Suggested Citation

Peters, Gary F. and Parker, Susan and Abbott, Lawrence J., Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses (June 2004). , . Available at SSRN: https://ssrn.com/abstract=649845 or http://dx.doi.org/10.2139/ssrn.649845

Gary F. Peters

University of Arkansas at Fayetteville ( email )

Sam M. Walton College of Business
Department of Accounting
Fayetteville, AR 72701

Susan Parker (Contact Author)

Santa Clara University ( email )

Leavey School of Business 500 El Camino Real
Santa Clara, CA 95053
United States
(408) 554-4899 (Phone)
(408) 554-5193 (Fax)

Lawrence J. Abbott

University of Memphis ( email )

Department of Accounting
Memphis, TN 38152
United States
901-678-4576 (Phone)
901-678-2685 (Fax)

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