Federal Judge Ideology and the Going Concern Reporting Incentives of Big 4 and Non-Big 4 Auditors

We analyze how variation in federal level legal liability associated with judge ideology affects the likelihood of firms receiving going-concern modified audit opinions. With auditors trading off between Type I and Type II reporting errors, the threshold value (of client bankruptcy probability) above which auditors issue going-concern reports is decreasing and convex in the level of federal litigation risk. Building on the literature showing that federal judge ideology affects the likelihood and outcome of lawsuits, we find that Big 4 and non-Big 4 auditors converge in their going-concern reporting decisions and Type I reporting error rates as federal litigation risk increases. This is caused by the greater effect of judge ideology on non-Big 4 than on Big 4 auditors. The key results remain with firm fixed effects and are not driven by the effects of judge ideology on auditor choice or bankruptcy probability