Auditor Liability and the Precision of Auditing Standards

This paper deals with the precision of auditing standards under a negligence liability system for auditors. Auditing standards such as, e.g., GAAS in the US and GoA in Germany provide rules for judging the auditors' due care and are supposed to serve both descriptive and normative purposes. In order to fulfill these functions, it is usually hypothesized that the standards must be made as precise as possible. This paper argues, however, that vague standards need not be detrimental. In fact, it is shown that for each precise standard there exists a vague standard that outperforms the precise standard equilibrium in terms of auditing efforts, quality of the financial statements, costs of using the legal system, and direct as well as total auditing costs.