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The Irrational Auditor and Irrational Liability

50 Pages Posted: 15 Feb 2006 Last revised: 23 Jul 2013

Adam C. Pritchard

University of Michigan Law School

Abstract

This essay argues that less liability for auditors in certain areas might encourage more accurate and useful financial statements, or at least equally accurate statements at a lower cost. Audit quality is promoted by three incentives: reputation, regulation, and litigation. When we take reputation and regulation into account, exposing auditors to potentially massive liability may undermine the effectiveness of reputation and regulation, thereby diminishing integrity of audited financial statements. The relation of litigation to the other incentives that promote audit quality has become more important in light of the sea change that occurred in the regulation of the auditing profession with the adoption of the Sarbanes-Oxley Act. Given these fundamental changes in the regulatory backdrop, I argue that the marginal benefit of litigation has been substantially diminished and in many cases that it is likely to be ineffective in promoting greater audit quality. I propose a knowledge standard for auditor liability in securities fraud cases.

JEL Classification: K22, M41

Suggested Citation

Pritchard, Adam C., The Irrational Auditor and Irrational Liability. Lewis & Clark Law Review, vol. 10, no. 1 (2006): 19-55; Michigan Legal Studies Research Paper No. 05-015. Available at SSRN: https://ssrn.com/abstract=883662

Adam C. Pritchard (Contact Author)

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4048 (Phone)
734-647-7349 (Fax)

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