The Effects of High Estimate Uncertainty in Auditor Negligence Litigation*

Abstract

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 because 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.

How Does High Uncertainty in Accounting Estimates Impact Auditor Litigation Risk? Opposite Effects in Jury Trials and Attorneys’ Out-of-Court Settlements

“…To compare the judgments of jurors and attorneys, Pickerd and Piercey (2021) had mock jurors and attorneys read a hypothetical audit litigation case, adapted from prior research (Kadous 2000(Kadous , 2001Peecher and Piercey 2008). Pickerd and Piercey (2021) used 218 college students as mock jurors.…”

“…To compare the judgments of jurors and attorneys, Pickerd and Piercey (2021) had mock jurors and attorneys read a hypothetical audit litigation case, adapted from prior research (Kadous 2000(Kadous , 2001Peecher and Piercey 2008). Pickerd and Piercey (2021) used 218 college students as mock jurors. Extensive prior research on juror judgments shows that college students behave extremely similarly to wider populations of jurors (e.g., Bornstein 1999).…”

“…R esearch suggests that contemporary accounting estimates require increasingly high levels of valuation uncertainty, which may make auditors more likely to experience negative outcomes in litigation (e.g., Christensen, Glover, and Wood 2013;Craig, Smieliauskas, and Amernic 2017). We review a recent study by Pickerd and Piercey (2021), which examines the way that high estimate uncertainty impacts auditor litigation risk and how it does so differently depending on whether an audit litigation case ends in a jury trial or is settled by attorneys out of court.…”

“…As a result, attorneys' beliefs about how jurors would decide a case could differ from how jurors actually decide it. Pickerd and Piercey (2021) conducted the first and only study of which we are aware that directly compares the judgments of mock jurors and attorneys evaluating the same case. 1 Their study finds that high estimate uncertainty, defined as susceptibility to an inherent lack of precision in measurement (American Institute of Certified Public Accountants (AICPA) 2011), impacts auditor liability in opposite directions, depending on how the case is resolved.…”

“…1 Their study finds that high estimate uncertainty, defined as susceptibility to an inherent lack of precision in measurement (American Institute of Certified Public Accountants (AICPA) 2011), impacts auditor liability in opposite directions, depending on how the case is resolved. The purpose of this article is to summarize the study of Pickerd and Piercey (2021) and report implications of the study's results for practice and academics.…”