（2004）Auditors’ Professional Liability, Liability Insurance and Audit Reliability.pdfVIP

Auditors’ Professional Liability, Liability Insurance and Audit Reliability Massood Yahya-Zadeh* School of Business and Public Management The George Washington University Abstract : Auditors provide assurance services and, as such, they are viewed by the investing public as guarantors of their investments in public corporations. Auditors and audit firms manage the risk from exposure to large lawsuits by shareholders of public corporations by purchasing liability insurance. This study examines the role of liability insurance in audit industry. Specifically, the auditors’ optimal choice of liability coverage and their incentives to exercise due care under alternative legal regimes are examined. An analytical model of auditor decision-making is used, where the extent of auditing procedures and client risk determine the probabilities of incorrect audit opinions. An insurance market is also introduced, where liability coverage can be purchased at premiums with zero or positive markups. The study argues that auditors may not always find it optimal to acquire liability insurance and, when they do, they may prefer acquiring only partial insurance coverage. The policy implication of this finding is that auditor liability insurance may not be the appropriate vehicle, as is argued in the U.S. courts, to spread the potential invest - ment losses to the accounting profession and eventually to the in