The Value of External Audits: Evidence from Voluntary Audits of Hedge Funds

• In Event: Governance Gatekeepers

Abstract

We investigate the merit of external audits using a rare set of hedge fund data. Our findings are as follows. We first document that hedge fund characteristics are significantly associated with funds’ decisions to purchase external audits. Controlling for the self-selected feature of external audit choices, we further document that the incidence of return misreporting for hedge funds is significantly lower in audited than unaudited periods. We also find that investors of audited funds are more willing to pay higher incentive fees than those of unaudited funds. Lastly, audited funds are rewarded for performance with capital inflows to a greater extent than unaudited funds are. Our findings hold under a battery of robustness tests.

Authors

• Dichu Bao, The Hong Kong Polytechnic University

• Jong-Hag Choi, Seoul National University

• Byoung Uk Kang, The Hong Kong Polytechnic University

• Woo-Jong Lee, Seoul National University