Strategic Considerations in Auditing Litigation and Settlement

• Main Authors: Hua Lee, 李華
• Other Authors: Taychang Wang
• Format: Others
• Language: en_US
• Published: 2001
• Online Access: http://ndltd.ncl.edu.tw/handle/69231516396320389770

博士 === 國立臺灣大學 === 會計學研究所 === 89 === It is widely recognized that the CPAs have been facing severe legal crises in the past decade, even after the enactment of the Private Securities Litigation Reform Act of 1995 or the Securities Litigation Uniform Standards Act of 1998. However, the low trial rate (8%, Palmrose, 1991) indicates that most legal disputes are either settled out of court or dropped. Nevertheless, defending against weak claims is financially burdensome and time-consuming. Once having gone to court, the court may commit legal errors, because under negligence liability the definition of the negligence is not clearly specified. In particular, compared to other kind of lawsuits (such as criminal or civil suits), in auditing litigation, the possible lack of expertise by the court in making correct judgment of standards of negligence in accounting and auditing further heightens the extent of legal error. The purpose of the dissertation is to analyze the strategic interactions between an auditor and an investor in a dynamic auditing litigation game, especially in the presence of legal error under negligence liability, when settlement bargaining is considered. In the first part of the thesis, we show that there exists a set of equilibrium strategies: the investor correctly conjectures the auditor’s chosen due care (audit effort), and proposes a settlement offer that the auditor will accept with certainty. By incorporating a damage penalty into the model as a compensation for the winning defendant (auditor), raising either the standard of negligence or the auditor’s expected litigation cost increases due care, while the effects of damage award, penalty, and legal error remain ambiguous. We also characterize the court’s choices of damage award and penalty subject to the auditor’s chosen due care. In the second part of the thesis, we then apply the model to compare litigation cost rules, the American rule, the British rule, the Proplaintiff rule, and the Prodefendant rule. The application of the model to the litigation cost allocation rule does not support practitioners’ advocacy for a move to the British rule. We show that the effort exerted by the auditors may be lower under British rule, which results in more high-probability-of-losing auditors going to trial.