The riskiness of large audit firm client portfolios and changes in audit liability regimes: Evidence from the US audit market

We investigate whether the financial riskiness of large U.S. audit firm clienteles varied with the changing audit litigation liability environment during the period 1975-99. Partitioning the period of study into four distinct periods (a benchmark period (1975-84), a period of increasing concerns about litigation liability (1985-89), a period of lobbying for reform (1990-94), and a post-relief period (1995-99)), we find some evidence of risk decreases during 1985-89, strong evidence of risk decreases during 1990-94, and strong evidence of risk increases during 1995-99. However, we also find that over the period of our study, a time during which Big 6 market shares grew appreciably, the proportion of litigious-industry clients in Big 6 client portfolios grew at about the same rate as the proportion of such clients in the population. Moreover, the Big 6 share of the financially riskiest clients in the economy did not grow as fast as the overall Big 6 market share. In sum, although our evidence is consistent with the hypothesis that the riskiness of Big 6 client portfolios responded to changes in the audit litigation liability environment, we find no systematic evidence of a "race to the bottom" or "bottom fishing" by these firms in a bid to increase their market shares.