The effect of auditor litigation risk on analyst coverage decisions: Evidence from a quasi-experiment

Abstract

Exploiting staggered state-level shocks to third-party auditor legal liability in the United States, we find that an exogenous increase in auditor litigation risk increases client firms' analyst following. The effect is more pronounced for firms with elevated litigation risk, greater forecast uncertainty, a more opaque information environment and those audited by auditors without industry expertise or with a history of poor audit quality. We also find that analysts are more likely to provide revenue and cash flows forecasts for the clients of auditors facing higher litigation risk. These findings highlight that increased auditor litigation risk enhances analysts' perception of audit quality.