An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures.pd

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Auditing: A Journal of Practice & Theory American Accounting Association Vol. 32, No. 2 DOI: 10.2308/ajpt-50354 May 2013 pp. 97–118 An Examination of the Legal Liability Associated with Outsourcing and Offshoring Audit Procedures Alex Lyubimov, Vicky Arnold, and Steve G. Sutton SUMMARY: Accounting firms have steadily increased the use of outsourcing and offshoring of professional services including independent audit procedures. While firms suggest that the work is of higher quality and similar litigation risk, questions remain as to whether public perceptions may be more negative. This paper examines liability associated with an audit failure when work is performed by another office of the same firm or outsourced to a separate firm, and whether the work is performed domestically or in another country. Results indicate main effects for outsourcing on compensatory damages and an interaction between outsourcing and offshoring on punitive damages. Surprisingly, jurors assess higher than expected litigation awards for a failure by another domestic office of the firm for punitive damages. This result suggests that the close proximity in terms of both geography and organizational distance of the domestic office of the firm leads jurors to find the audit failure less understandable. Post hoc analyses indicate that potential jurors perceive that work completed by another domestic office of the firm has the highest expected quality and lowest risk, while work that is outsourced offshore is expected to be lowest quality and highest risk—consistent with proximity theory. Keywords: outsourcing; offshoring; audit quality; litigation risk; juror decision-making; auditor liability; counterfactual reasoning. Alex Lyubimov is a Ph.D. student, and Vicky Arnold and Steve G. Sutton are both Professors, all at the University of Central Florida . We thank Donna Bobek Schmitt, Mary Curtis, Naman Desai, Andy Dill, Craig Emby, Michael Favere-Marchesi, Don Finn, Govind Iyer, Theresa Libby, Jeff Reinking, Jesse Robertson, Kim Zahller, workshop participants at the AAA Auditing Section Midyear Meeting, Simon Fraser University, University of Central Florida, and University of North Texas, and students in the Behavioral Research in Accounting Ph.D. Seminar at the University of Waterloo for their helpful comments. We also thank Mike Bamber (associate editor) and two anonymous reviewers for their helpful comments. We thank Kathryn Kadous and Jordan Lowe for giving us permission to use portions of their instruments for this study, and Charles Lako for providing legal insight regarding the instrument. Editor’s note: Accepted by E. Michael Bamber. Submitted: April 2011 Accepted: October 2012 Published Online: November 2012 97
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INTRODUCTION I nternational and national accounting firms frequently outsource work to other smaller domestic firms (Bandyopadhyay and Hall 2008 ). In the past decade, outsourcing has increasingly been opened to offshore outsourcing partners, first in tax ( Blackman et al. 2004; Mintz 2004; Shamis et al. 2005; Brody et al. 2006)

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