Client-specific litigation risk and audit quality differentiation

Purpose – The purpose of this study is to examine whether client-specific litigation risk affects the audit quality differentiation between Big N and non-Big N auditors. Specifically, we examine whether higher quality audits of Big N auditors relative to nonBig auditors is more pronounced for clients with high litigation risk than for clients with low litigation risk. Design/methodology/approach – We develop the hypothesis based on auditors’ potential monetary and reputational losses, collect the data of U.S. listed companies from the Compustat and CRSP databases, and conduct regression analyses. Findings – We find that the higher effectiveness of Big N auditors over non-Big N auditors in constraining earning management is greater for high litigation risk clients than for low litigation risk clients, suggesting that clients’ high litigation risk can force big auditors to perform more effectively. Originality/value – This study contributes to the literature by providing novel evidence on the effect of client-specific litigation risk on the audit quality differentiation between Big N and non-Big N auditors. Our findings complement the extant research on the relationship between the audit quality differentiation and country-level litigation risk.