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Do Auditors Accurately Predict Litigation and Reputation Consequences of Inaccurate Accounting Estimates?

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  • Christine Gimbar
  • Molly Mercer

Abstract

To effectively manage audit risk, auditors must correctly predict the potential litigation and reputation consequences associated with inaccurate accounting estimates. Accurate predictions are critical because underestimation of negative consequences leads to excess legal exposure and overestimation leads to overauditing. Our paper examines whether auditors correctly anticipate these litigation and reputation outcomes. We provide manager‐ and partner‐level auditors with case facts from an auditor negligence lawsuit and ask them to predict the proportion of juries that will return verdicts against their firm. We then compare auditors' predictions to the actual verdicts we observe when we provide the same set of case facts to mock jurors who deliberate as part of juries. We find that auditors overestimate the likelihood of negligence verdicts, especially when audit quality is relatively high. Our supplemental measures help explain the reasons for this overestimation: auditors tend to underestimate jurors' perceptions of audit quality and willingness to attribute inaccurate estimates to situational factors. Finally, we examine auditors' predictions about how a news article about the litigation will affect their reputation with the general public. Similar to our litigation results, we find that auditors tend to overestimate the article's negative impact on auditor reputation. Collectively, our findings suggest that auditors overestimate litigation and reputation consequences resulting from inaccurate accounting estimates. This overestimation is consequential as it leads to inefficient allocation of audit resources. Les auditeurs prédisent‐ils avec exactitude les conséquences des estimations comptables inexactes sur le plan des litiges et de la réputation? Pour gérer efficacement le risque d'audit, les auditeurs doivent prédire correctement les conséquences possibles sur le plan des litiges et de la réputation associées aux estimations comptables inexactes. L'exactitude des prédictions est essentielle, car la sous‐estimation des conséquences négatives mène à un risque de poursuites trop élevé, alors que leur surestimation conduit à un excès d'audit. Dans le cadre de notre étude, nous vérifions si les auditeurs prédisent adéquatement les répercussions sur le plan des litiges et de la réputation. Nous présentons à des auditeurs cadres ou associés des données factuelles tirées d'une poursuite pour négligence visant un auditeur et leur demandons de prédire la proportion de membres du jury qui rendront un verdict contre leur société. Nous comparons ensuite leurs prévisions avec les verdicts réels obtenus lorsque nous soumettons les mêmes données à des jurés fictifs participant aux délibérations d'un jury. Nous constatons que les auditeurs surestiment la possibilité de verdicts de négligence, en particulier lorsque la qualité de l'audit est élevée. Nos mesures supplémentaires aident à dégager les motifs de cette surestimation : les auditeurs ont tendance à sous‐estimer les perceptions des jurés sur la qualité de l'audit et leur propension à expliquer les estimations inexactes par des facteurs situationnels. Enfin, nous examinons les prédictions des auditeurs sur l'incidence d'un article de presse traitant du litige sur leur réputation auprès du public. Comme dans le cas de l'évaluation des possibilités de litige, nous montrons que les auditeurs sont enclins à surestimer l'impact négatif de l'article sur la réputation de l'auditeur. Dans l'ensemble, nos résultats laissent entendre que les auditeurs surestiment les conséquences des estimations comptables inexactes sur le plan des litiges et de la réputation. Cette surestimation n'est pas sans impact, car elle conduit à une allocation inefficace des ressources d'audit.

Suggested Citation

  • Christine Gimbar & Molly Mercer, 2021. "Do Auditors Accurately Predict Litigation and Reputation Consequences of Inaccurate Accounting Estimates?," Contemporary Accounting Research, John Wiley & Sons, vol. 38(1), pages 276-301, March.
  • Handle: RePEc:wly:coacre:v:38:y:2021:i:1:p:276-301
    DOI: 10.1111/1911-3846.12629
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