Shareholder Litigation Risk and Stakeholders: Evidence from the Auditor Perspective

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Abstract

This paper analyzes the impact of state-level adoption of universal demand (UD) laws in the United States, and the resulting reduction in shareholder litigation, on auditor pricing and the quality of financial reporting. UD laws, adopted by 23 states between 1989 and 2005, limit the ability of shareholders to initiate litigation, thereby reducing shareholder oversight and increasing agency conflicts. We corroborate our findings regarding the impact of UD law adoption through analysis of a secondary source of external oversight – the outside auditor. We observe a 10% reduction in audit fees, reduced audit report lag, and improved financial reporting quality for firms operating in states that adopt UD laws. These findings suggest that in the aftermath of UD law adoption, auditors reduce effort and lower fees, while firms improve the quality of their financial reporting to mitigate adverse effects resulting from an increase in agency conflicts attributable to the adoption of UD laws. This paper addresses the important question of how auditor’s perceive and react to a limitation on shareholder litigation, presents evidence that firms improve the quality of their financial reporting in response to an increase in agency conflicts, and contributes to the emerging literature on the impact of UD laws.

Authors

• Alona Bilokha, Fordham University

• Joon Ho Kong, Fordham University

• Joseph Micale, Fordham University