Auditor decision-making in different litigation environments: The Private Securities Litigation Reform Act, audit reports and audit firm size

The adoption of the Private Securities Litigation Reform Act of 1995 had a marked impact on public accounting firms in the US by significantly reducing their liability exposure with respect to litigation involving publicly traded audit clients. This shift in the litigation environment of public accounting firms has been argued to have been manifest in changed auditor decisions regarding their audit clients. While this tort reform legislation was intended to benefit all audit firms, recent research suggests that it may have differentially affected auditors based on audit firm size. In this study, we examine the impact of the change in litigation environment ushered in by the Private Securities Litigation Reform Act and Big 6 membership on going-concern modification decisions for companies entering bankruptcy before and after the new legislation. Our findings, based on analyses of 694 financially stressed firms that entered into bankruptcy during the period 1991 to 2001, indicate that the likelihood of a going-concern modified opinion decreased significantly after the Private Securities Litigation Reform Act, and the change was particularly pronounced for the Big 6 audit firms. These results suggest that this important litigation reform had a significant effect on auditor decision-making, and that it had more of an effect on audit decisions of the Big 6 firms in comparison to the non-Big 6 firms.