Litigation and agency problems in audit firms

This thesis analyzes litigation and agency problems in public accounting firms. The first essay, 'An Analysis of Auditor Liability Rules', looks at the likely impact of the proposed switch from the joint and several liability regime to the proportional liability regime. The essay shows that moving to proportional liability may actually improve audit quality. This can happen because litigation damages are more sensitive to auditor effort under proportional liability than under joint and several liability. The essay recognizes trial lawyers as strategic players and models their incentives to file suits. The essay also compares the strict liability standard of care and the negligence standard of care under the two liability regimes.;The second essay, 'Litigation and Compensation of Partners in Accounting Firms', looks at incentive contracts among partners of audit firms. If profits in accounting firms are shared then partners will shirk because of the budget-balancing constraint. To mitigate this moral hazard problem we introduce bonus schemes that motivate partners to increase the revenue of the audit firm. Partners respond to such incentives by increasing not only their effort but also the risk level (in terms of the quality of clients they are willing to accept and in their choice of auditing procedures) that results in litigation losses to the audit firm. Penalties can rectify the inefficiencies in effort and risk level choice but wealth constraints on maximum penalties that can be imposed, ensure that full efficiency is not attained.;The third essay, 'Moral Hazard in Repeated Professional Partnerships', uses a repeated game framework to study how audit firms mitigate the moral hazard problem caused by the budget-balancing constraint. Threat of non-cooperation ensures that in a repeated partnership game, the outcomes are Pareto superior to the outcomes in a one-period game. The threat of expulsions are also modeled. Differential work aversion is introduced to explain expulsions in equilibrium.