Auditors’ legal liability and client firms’ comparability: evidence from China
ISSN: 0268-6902
Article publication date: 14 April 2023
Issue publication date: 22 May 2023
Abstract
Purpose
This paper aims to investigate the relation between audit firms’ switch to limited liability partnership (LLP) from limited liability company (LLC) and client firms’ earnings comparability. If LLP auditors, who have a higher liability exposure than LLC auditors, are more consistent in implementing generally accepted accounting principles and executing firm-wide audit methodologies, client firms’ earnings comparability will increase.
Design/methodology/approach
Using data from China, the authors examine whether client firm-pairs of LLP auditors have higher earnings comparability than client firm-pairs of LLC auditors. The authors also perform cross-sectional tests to shed light on the mechanisms through which auditors’ litigation exposure affects client firms’ comparability.
Findings
The authors find that firm-pairs in which both firms are audited by LLP auditors exhibit higher earnings comparability than other firm-pairs. This result is stronger when client firms are audited by the same auditor, when client firms are audited by the top 10 auditors and when the auditors are less dependent on the client firms. The authors also document that firm-pairs in which both firms are audited by LLP auditors have lower average analyst earnings forecast error and forecast dispersion.
Originality/value
To the best of the author’s knowledge, this study is the first to examine the relation between auditor’s litigation exposure and client firms’ earnings comparability. It also extends the literature on audit firm organizational form and audit quality.
Keywords
Acknowledgements
The authors thank Yew Kee Ho (Associate Editor), two anonymous reviewers, Yu-Tzu Chang, Chien-Min Kevin Pan, Anxuan Xie and Chun-Chan Yu for helpful comments. Xiaohai Long and Yanghui Liu gratefully acknowledge financial support from the National Natural Science Foundation of China (Project: 71762034) and Jiangxi National Social Science Fund (Project: 22YJ50D). Yanghui Liu gratefully acknowledge financial support from Jiangxi University Humanities and Social Science Fund (Project:JJ22212), Jiangxi Provincial Department of Education Science and Technology Fund (Project: GJJ2200631). Wuchun Chi gratefully acknowledge financial support from National Science Council (Project No. MOST107-2410-H-004-030-MY3).
Citation
Liu, Y., Chen, J.Z., Chi, W. and Long, X. (2023), "Auditors’ legal liability and client firms’ comparability: evidence from China", Managerial Auditing Journal, Vol. 38 No. 5, pp. 685-709. https://doi.org/10.1108/MAJ-05-2022-3566
Publisher
:Emerald Publishing Limited
Copyright © 2023, Emerald Publishing Limited