Accounting misstatements following lawsuits against auditors.

Clive Lennox & Bing Li 

Journal of Accounting and Economics

In Press (2013)

Abstract:

• This study investigates whether an auditor's experience of litigation in the recent past affects subsequent financial reporting quality.
• At the audit firm level,we find accounting misstatements occur significantly less (more) often after audit firms are sued (not sued).
• At the audit office level,the negative association between past litigation and future misstatements is stronger for offices who were directly implicated in the litigation than for the non-accused offices of sued audit firms.
• Therefore,the litigation experiences of both audit firms and audit offices are incrementally significant predictors of future financial reporting quality.

Discussions:

Prof Lennox is from NTU (probably one of the most reputable univ for accounting research in Asia Pacific?) while Prof Li is from City Univ of HK (NTU alumni). The findings here are not very surprising as they cogently explained in the introduction: drivers who are caught speeding are less likely to speed in the future while drivers who never caught speeding  feel that they will never get caught and speed more! Same here with auditors. Litigation experience improves auditors' performance. 

So a key take away for companies that intend to improve their FS quality is this: Hire auditor that has been sued before! So,  Arthur Andersen anyone?

Interesting data:

Table 3: Total Law suits against audit firms and audit offices (2001–2010)

Ernst &Young                         182
PricewaterhouseCoopers         194
Deloitte&Touche                     139
KPMG                                   161
Grant Thornton                        35

BDO Seidman                         40