Academic journal article Auditing: A Journal of Practice & Theory

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

Academic journal article Auditing: A Journal of Practice & Theory

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

Article excerpt

INTRODUCTION

Reputation is believed to be an important success factor for auditors (Wilson and Grimlund 1990; Brozovsky and Richardson 1998). Thus, auditors' decisions and actions should be influenced by reputation concerns. That is, auditors are expected to exert efforts to maintain positive aspects of their reputation. Prior research, however, has not concentrated on the impact of reputation on auditors' decisions and actions.

Reputation is a complex, multidimensional construct, making it difficult to examine. This study focuses on one specific aspect of reputation important to auditors--an auditor's litigation reputation as a "settler" or as a "fighter" (Che and Yi 1993). Auditors have the opportunity to develop and protect litigation reputation due to the often high likelihood of becoming a repeat defendant (Alexander 1991). Settling is usually the least costly method of resolving litigation in the short run. Economic theory suggests that defendants settle cases quickly to avoid the legal costs of fighting a ease in court, which can quickly accumulate and exceed settlement costs (Daughety 2000; Scott and Zhang 1997). Further, there is the worry that, since court judgments are public record, there is the risk that the publicity may harm the name of the auditing firm. Thus, one might suspect that a settling strategy is optimal.

However, settling may encourage potential plaintiffs to bring more lawsuits against the auditor. A fighter reputation, which may appear inappropriate from an economic standpoint, especially in the short-run, may be the optimal choice for an auditor who could face several future litigation cases. A litigation strategy of developing a fighter reputation may deter potential plaintiffs seeking a quick settlement. Thus, auditors have an incentive to develop a reputation for fighting litigation cases with plaintiffs.

Recent analytical audit litigation research has illustrated that strategies to fight cases in court exist and should be applied when involved in a litigation ease to deter future cases, especially if there is a high probability of becoming a repeat defendant (Cushing and Gilbertson 2002; Matsumura et al. 2001). Prior audit research also speculates that auditors strategically exert effort and incur expense to develop a litigation reputation but does not provide supporting empirical evidence (Menon and Williams 1991; Craswell et al. 1995; Rollins and Bremser 1998). Therefore, the purpose of this study is to investigate whether auditors strategically choose to protect litigation reputation by selecting to fight cases in court.

This study investigates auditor decisions and outcomes in a settlement negotiation regarding pending litigation to determine whether auditors strategically take costly actions to protect their litigation reputation. It argues that reputation concerns will influence auditors' decisions and ultimate outcomes when dealing with the litigation ease. Auditors will elect to fight the ease in court to cut costs of future litigation, regardless of the merits of the ease (Alexander 1991; Palmrose 1991). It also explores whether these reputational concerns and resulting strategies develop and strengthen with an auditor's experience and tenure as an audit professional.

An experiment is conducted in which 48 audit partners negotiate two settlements regarding an audit litigation ease. The ability to protect reputation is manipulated by varying whether the outcome of the first negotiation is observable to the second negotiation partner. When the outcome is observable, a strategy can be developed whereby reputation for fighting earl be protected. It is expected that reputational concerns will influence audit partners' behaviors and decisions. Specifically, audit partners will be less willing to predict that their side will lose and to settle even though settling is less costly in the short-run in the observable condition. Auditors will thus balance short-nm and long-run costs. …

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