Auditors' Strategies to Protect Their Litigation Reputation: A Research Note

Abstract

Litigation may be harmful in terms of direct costs such as damages and defense costs, as well as indirect costs such as harming the auditor's general reputation and name. When a case is initiated, the auditor may choose to settle out of court or fight. Often settling is less costly in the short run, but may be costlier in the long run as the auditor develops a reputation for not fighting, thus, inducing greater future litigation. This study investigates whether reputational concerns for future litigation motivate auditors to strategically take costly actions to fight rather than settle. I use an experiment involving 48 partners to examine auditors' actions in a situation where auditors report their litigation outcomes to future litigants, allowing them to develop reputations, and a situation where auditors do not report their litigation outcomes. As predicted, I find that auditors take costly actions to protect their litigation reputation. Auditors are more likely to predict that their side will win and have more difficulty settling, even if settling is less costly, when reputation can be protected as compared to when it cannot. In contrast, inexperienced auditors are not influenced by reputation concerns. Thus, litigation reputation concerns that influence auditors' decisions and actions appear to develop with an auditor's experience and tenure in the audit profession.

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