Do Non-Audit Service Fees Affect the Outcome and Occurrence of Auditor Litigation?

Jaime Schmidt, The University of Texas at Austin

ABSTRACT: This paper examines the occurrence of auditor litigation related to financial statement misstatements and the effect of misstatement-based litigation on subsequent auditor behavior. I find that auditor misstatement-based litigation is more likely when the misstatement is associated with fraud, a regulatory investigation, a larger stock price decline, and/or a greater number of accounting application failures. In addition, I find that auditor misstatement-based litigation is more likely when the misstatement is associated with a greater magnitude and/or proportion of non-audit service fees. With respect to subsequent auditor behavior, I find evidence that auditor litigation results in more conservative auditor behavior across a litigated auditor’s office-wide client portfolio. Specifically, in the year following auditor litigation, I find evidence that litigation results in an increased constraint of client-reported signed discretionary accruals as well as longer audit report lags.

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