Managerial Litigation Risk and Auditor Choice
Posted: 6 Feb 2019
Date Written: January 31, 2019
Our study investigates the causal relationship between managers’ personal litigation risk and their firm’s auditor choice decisions. Exploiting the staggered adoption of universal demand (UD) laws at the state-level in the U.S., we use a difference-in-differences analysis and find a higher propensity for affected firms to switch to higher-quality auditors after the exogenous reduction of managerial litigation risk. This result supports the hypothesis that managers are motivated to increase transparency and reduce agency costs when agency conflicts between managers and outsiders increase. In addition, we document that switching to a higher-quality auditor mitigates the negative effects of UD laws on a firm’s cost of equity. Finally, audit fee premium for each unit of discretionary accruals increases for the affected firms, compared to the control firms during the same period. Our study contributes to our understanding of how regulatory changes that have an impact on agency problems affect firms’ demand for auditing.
Keywords: Auditor Switching; Auditor Choice; Audit Fees; Cost of Equity; Derivative Lawsuits; Shareholder Litigation; Universal Demand Laws
JEL Classification: K20; M42
Suggested Citation: Suggested Citation