Economic aspects of audit regulation and auditor liability

This thesis provides one of the first (to the author's knowledge, the first) micro-economic analyses of audit regulation and auditor liability. The analysis draws on insights from the economics and law literature that liability and regulation affect behaviour of individuals and organisations. The major research questions addressed in the thesis are the following: 1) How is demand for external audit services affected by joint and several liability of directors and external auditors? 2) How do auditor liability and professional audit standards affect audit quality? 3) Is it in the public interest to use auditor liability and professional audit standards jointly to monitor audit quality? The analysis is general, in the sense that a number of alternative regulatory scenarios are considered, and therefore hopes to be of relevance to various legal environments. Propositions about audit demand and production behaviour are drawn, as well as corollaries about the welfare implications of audit regulation and liability. Some major conclusions from the economic analysis are the following. 1) Consistency in judicial reasoning should be promoted. Certainty about what constitutes 'due care' leads to compliance by directors and auditors. 2) Uncertainty about due care crucially affects behaviour, both of auditors and directors. 3) Liability insurance arguments are irrelevant for audit demand when the due care level for directors is fairly certain. 4) Statutory audit requirements should only be imposed under limited circumstances. 5) More prescriptive professional audit standards have a positive effect on audit quality, but one standard for all client situations can never lead to social efficiency. 6) Liability restriction has a negative effect on audit quality. It may however promote socially efficient behaviour when there is overproduction of audit quality. 7) The joint use of liability restriction and more prescriptive professional audit standards may lead to a status quo in terms of audit quality produced, and therefore not welfare improving