Auditor liability rules under imperfect information and costly litigation: the welfare-increasing effect of liability insurance

Ralf Ewert, Eberhard Feess () and Martin Nell

European Accounting Review, 2000, vol. 9, issue 3, 371-385

Abstract: This paper examines auditor liability rules under imperfect information, costly litigation and risk-averse auditors. A negligence rule fails in such a setting, because in equilibrium auditors will deviate with positive probability from any given standard. It is shown that strict liability outperforms negligence with respect to risk allocation and the probability that a desired level of care is met by the auditor if competitive liability insurance markets exist. Furthermore, our model explains the existence of insurance contracts containing obligations a type of contract often observed in liability insurance markets.

Date: 2000
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DOI: 10.1080/09638180020017122

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