StoneRidge Investment Partners v. Scientific Atlanta: A Test of Auditor Litigation Risk

This paper examines the effects of a decrease in auditor litigation risk in a setting that isolates a change in auditor litigation risk from changes in auditor reputation. StoneRidge Investment Partners v. Scientific Atlanta is a 2008 U.S. Supreme Court ruling that restricted secondary actor liability in class action suits, resulting in a decrease in class actions that listed auditors as defendants. We document that the StoneRidge decision is associated with a negative CAR for clients of Big 4 auditors and industry specialist auditors, in particular those associated with high-litigation risk, low cash, and past incidences of modified going concern opinions. These findings are consistent with investor perception of lower potential payoffs from secondary defendants in class action suits, in particular auditors, following the StoneRidge decision. We also document that auditors are more (less) likely to accept (reject) risky clients and charge lower audit fees to risky clients after StoneRidge, consistent with a decrease in auditor litigation risk that increases auditor risk tolerance. Finally, we provide evidence that audit firms issue fewer going concern opinions following StoneRidge, consistent with a decrease in litigation risk leading to lower audit quality. Our results are relevant to policy makers as they consider the disciplinary role of litigation on audit markets.