Legal Penalties and Audit Quality: An Experimental Investigation*

Ronald R. King and Rachel Schwartz

Contemporary Accounting Research, 1999, vol. 16, issue 4, 685-710

Abstract: The purpose of this paper is to investigate the impact of legal penalties on audit quality under different legal regimes. We investigate whether audit quality is affected differentially due to the complexity inherent in legal regimes and the frequency of imposing legal penalties. Economic theory predicts that players adopt equilibrium strategies that reflect the expectation that a penalty will be incurred, but the actual occurrences of penalties, if consistent with this expectation, should not prompt an individual to modify his or her strategy. However, learning theory suggests that players' choices will be repeated in the future based on outcomes. We found that penalties triggered both increases and decreases in effort, and seemed to introduce a “shock†that increased the variability of effort. We also observed a “funnel†effect — that is. greater changes in effort closer to the imposition of penalties, and smaller changes as more periods go by without a penalty.

Date: 1999
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https://doi.org/10.1111/j.1911-3846.1999.tb00601.x

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Persistent link: https://EconPapers.repec.org/RePEc:wly:coacre:v:16:y:1999:i:4:p:685-710

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