SMITH BRAIN TRUST – History shows that where financial auditing goes, litigation and reputational risk follow. While auditors incur risk of being sued and having their credibility damaged for substandard performance, their clients subsequently face exposure, but differently.
Research by accounting professor Hanna Lee at the University of Maryland’s Robert H. Smith School of Business shows that companies that are clients of litigated auditors have to pay more to borrow money.
The impetus for this work? “Except for some well-publicized anecdotal evidence related to auditor collapses or regulatory sanctions imposed on auditors, there is a dearth of empirical evidence on how auditor litigation and the subsequent reputational damage influence external capital market participants,” write Lee and her co-authors.
Their research focused on data spanning 15 years from a sample of firms not involved in litigation but whose auditors were sued for alleged audit failures. They found that banks do weigh auditor litigation in their credit risk assessments, but to varying degrees according to borrower and auditor characteristics. For example, higher interest rates are more pronounced for borrower firms whose auditors work with low transparency and/or auditors not among the ‘Big 4’ (Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers).
The findings lay groundwork to investigate perhaps how the severity of litigation in auditing cases affects the interest rates, the authors write. And further investigation could explore the extent to which auditor litigation and reputation is weighed by stock or bond market investors.
Read more: Do Banks Care about Litigation against Auditors of Borrower Firms? Evidence from Bank Loan Pricing is a working paper co-authored by Hanna Lee with Seoul National University’s Jong-Hag Choi and Wonsuk Ha.
Hanna Lee is an assistant professor of accounting and information assurance at the University of Maryland’s Robert H. Smith School of Business.
Research interests: Predictive information in financial statements, usefulness of accounting information in debt markets, default prediction, disclosure, and financial reporting quality.
Selected accomplishments: Presented her study investigating the increase in forecasting accuracy of hazard rate bankruptcy predication models with creditor coordination effects at the 2011 American Accounting Association Annual Meetings. Completed her doctoral work at Columbia University and earned a master’s degree in statistics from Harvard University, a BS at Seoul National University, and studied economics for a summer at the London School of Economics. Worked professionally for Goldman Sachs in New York, Deutsche Bank and Citibank in Seoul, South Korea, and AsiaNet Corp.
About this series: Maryland Smith celebrates Women Leading Research during Women’s History Month. The initiative is organized in partnership with ADVANCE, an initiative to transform the University of Maryland by investing in a culture of inclusive excellence. Other Women's History Month activities include the eighth annual Women Leading Women forum on March 5, 2019.
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