Do auditors price litigious tone?

Abstract

We investigate whether audit fees are shaped by litigious tone. Using a sample of listed firms in the US, we find litigious tone in 10-K reports is associated with higher audit fees. This finding remains robust when we account for sample selection bias, firm-level unobserved heterogeneity effects, endogeneity concerns, or when subsections in 10-K reports are analysed. In addition, we document the relationship is of a lower magnitude among high-risk client firms, suggesting that auditors are already cautious when auditing high-risk clients. This suggests that auditors rely less on litigious tone in determining audit fees when faced with high-risk clients.