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Three Essays on Auditor Liability

Auditor liability is an important topic of accounting research as auditors respond to a constantly changing financial reporting and regulatory environment. Through three independent essays, I intend to explore how estimate uncertainty, financial statement aggregation, audit quality indicators, a company's investor base, and the size of the alleged misstatement can impact auditor liability both in the courtroom, as determined by jurors, and in out of court settlement, as determined by attorneys. I find that jurors do hold the auditor more likely to be negligent when audit quality indicators suggest the auditors did a poor quality audit. I also find that jurors hold auditors to be more negligent when both estimate uncertainty is low and the income statement is disaggregated. This juror finding is in contrast to lawyers where I find that high estimate uncertainty causes auditors’ lawyers to believe that the auditors are more vulnerable for failing to detect a material misstatement and make more concessions in out-of-court settlement negotiation. Together, these studies have a number of important implications. First, the impact of high estimate uncertainty on auditor liability can go in opposite directions depending on whether the case disposition is determined by jurors or by lawyers negotiating settlement. Second, auditors’ legal counsel may erroneously concede during settlement negotiations based on incorrect beliefs about their vulnerability to jurors. Third, while accounting research has focused on juror judgments to proxy for auditor litigation risk, auditors may face very different litigation risk in out-of-court settlement, where the vast majority of auditor liability is determined.