Auditor Litigation Risk and Capital Structure Dynamics

We examine the effect of auditor litigation risk on firm capital structure decisions by exploiting staggered state-level shocks to third-party auditor legal liability in the United States. We find that an exogenous increase in auditor litigation risk leads to an increase in firm leverage ratios and an increase in the probability of using debt of longer term maturities. We also find that firms in states with increased auditor litigation risk increase leverage to optimal debt levels compared to firms in states with lower auditor litigation risk. Overall, our findings, which withstand a variety of robustness tests, highlight the important role of liability against auditor negligence in corporate financing decisions