Abnormal CSR Performance and Auditor Litigation Risk

Abstract

Recent studies provide evidence that corporate social responsibility (CSR) conscious firms are less likely to engage in high-profile corporate misconduct and be subject to SEC investigations, suggesting that auditor litigation risk may be lower for better CSR performers. However, we argue that the association between CSR performance and auditor litigation risk may not be linear for two reasons. First, for a given level of audit risk, the lower the perceived risk of material misstatement, the higher the actual detection risk. Second, ceteris paribus, an incorrectly assessed low audit risk acceptable for abnormally high CSR performance would also increase auditor’s actual detection risk. Using a matched sample analysis for the period of 2004 to 2013, this study finds that the propensity for auditors to be sued first decreases as CSR performance improves, but then increases with excessively high abnormal CSR performance. Further analyses indicate that the convexity of CSR performance on auditor detection risk arises from the inherent risk channel (client business risk, financial misreporting, and earnings management), but not from the control risk channel (internal control material weaknesses). This study provides new insights on the signaling value of CSR performance on an auditor’s litigation risk.