University of Michigan Legal Working Paper Series
University of Michigan John M. Olin Center for Law & Economics Working Paper Series
The Irrational Auditor and Irrational Liability
Abstract
This essay argues that less liability for auditors in certain areas might encourage more accurate and useful financial statements, or at least equally accurate statements at a lower cost. Audit quality is promoted by three incentives: reputation, regulation, and litigation. When we take reputation and regulation into account, exposing auditors to potentially massive liability may undermine the effectiveness of reputation and regulation, thereby diminishing integrity of audited financial statements. The relation of litigation to the other incentives that promote audit quality has become more important in light of the sea change that occurred in the regulation of the auditing profession with the adoption of the Sarbanes-Oxley Act. Given these fundamental changes in the regulatory backdrop, I argue that the marginal benefit of litigation has been substantially diminished and in many cases that it is likely to be ineffective in promoting greater audit quality. I propose a knowledge standard for auditor liability in securities fraud cases.
Subject Area
Securities Law
Recommended Citation
Adam C. Pritchard,
"The Irrational Auditor and Irrational Liability"
(November 2005).
University of Michigan Legal Working Paper Series.
University of Michigan John M. Olin Center for Law & Economics Working Paper Series.
Working Paper 57.
http://law.bepress.com/umichlwps/olin/art57
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