Could That Happen to Me? Auditor Response When Colleagues Are Named in Lawsuits

ABSTRACT Litigation risk is an important source of motivation for auditors to conduct high‐quality audits, but theory suggests that certain lawsuits will have a more salient disciplining effect on auditor behavior. To this end, we identify lawsuits naming an individual partner as a co‐defendant along with the audit firm. We then examine how these lawsuits affect subsequent behavior of other auditors in the office of the sued partner. Relative to lawsuits naming only the firm, our results indicate that lawsuits naming individual partners as co‐defendants are significant office‐level events that motivate a meaningful response from non‐sued audit partners in the form of higher quality and fees on existing clients and more careful client portfolio management. These results have practical implications about how auditor litigation incentivizes individual auditors to fulfill their professional duties. For regulators and audit firms seeking to promote audit quality, these findings highlight the disciplining effect of auditors' concern for their personal reputation and litigation exposure. Furthermore, audit committees, clients, and investors may observe elevated audit quality, effort, and fees following partner‐level litigation in the local office.