The Effects of High Estimate Uncertainty in Auditor Negligence Litigation

We examine how jurors’ negligence judgments and attorneys’ out-of-court settlements are differently impacted by two features of a materially misstated accounting estimate—the amount of estimate uncertainty and whether the misstated account is disaggregated into its own line-item or aggregated with other accounts into a single financial statement line-item. We predict and find that jurors and attorneys react to estimate uncertainty in opposite directions under common conditions. This finding is important because, when jurors’ judgments and attorneys’ settlements differ, research into juror judgments alone may not capture a complete picture of auditor liability, since the vast majority of audit litigation is resolved by attorneys in out-of-court settlement without ever going to trial. Consistent with attribution theory, results from our first experiment show that jurors hold auditors more responsible for misstatements of lower estimate uncertainty when the misstated account is disaggregated, as opposed to misstatements that are of higher uncertainty and/or aggregated with other, accurate accounts. However, in a second experiment we find that attorneys negotiate auditor settlements under the incorrect assumption that jurors will hold auditors more responsible for failing to prevent misstatements of higher uncertainty. Our results illustrate that accounting research should not focus solely on juror judgments in the study of how specific factors impact auditor liability, and that attorneys would benefit from a better understanding of juror decision making