Auditor Liability and Business Investment

Posted: 10 Jul 2006

See all articles by Chiawen Liu

Chiawen Liu

National Taiwan University - Department of Accounting

Taychang Wang

National Taiwan University


We model a firm's investment decision, an auditor's effort-rendering behavior, audit fees, and prices of the firms under two auditor liability rules: strict liability and negligence liability. We show that an auditor's effort level is socially optimal under strict liability, while it is not generally so under negligence liability. Further, both the firm owner's expected benefit and the audit fee are higher under strict liability than under negligence liability. We define the legal error under negligence liability as the difference between the assessed audit effort (i.e., the estimate of audit effort made by the court) and the actual audit effort and prove that the greater the variance of the legal error, the more incentive an auditor has to exert effort under negligence liability compared to strict liability. Finally, the number of investments being undertaken could be higher under strict liability since more firm owners are willing to hire auditors to go public.

Keywords: auditor liability, investment, negligence liability, strict liability

JEL Classification: M49, D41, K13, G31

Suggested Citation

Liu, Chiawen and Wang, Taychang, Auditor Liability and Business Investment. Contemporary Accounting Research, Vol. 23, No. 4, Winter 2006. Available at SSRN:

Chiawen Liu (Contact Author)

National Taiwan University - Department of Accounting ( email )

50 Lane 144, Section 4
Roosevelt Road
Daan, Taipei 106
886-2-33661126 (Phone)
886-2-23638038 (Fax)

Taychang Wang

National Taiwan University ( email )

50 Lane 144, Section 4
Taipei 32026
+886-2-2363-0231, ext. 2960 (Phone)
+886-2-2363-8038 (Fax)

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