Auditor Responses to Shareholder Activism

Abstract

In this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions and first‐time going concern opinions. Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors’ concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse internal control opinions documented in our baseline tests reflects higher quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.