The Effect of Hedge Fund Activism on Auditors: A Stakeholder’s Perspective

Abstract

Extant literature focuses on the governance effect of hedge fund activism on shareholders but overlooks other stakeholders. We fill this literature gap by investigating one important stakeholder who also plays a governance role: the auditor. We find that the governance effect of hedge fund activism spills over to incumbent auditors, leading to a 4.08% increase in audit fees. This relation holds in a range of robustness tests that address endogeneity, including a difference-in-differences model and a placebo test. Moreover, auditor turnover does not significantly change after hedge fund intervention, suggesting that hedge funds do not seek new auditors. The governance spillover effect on incumbent auditors occurs through the revelation of internal control weaknesses and replacement of financial personnel in target firms. Further tests show that the increased audit fees are allotted to more audit effort and reduce the likelihood of restatements, indicating improved audit quality. Our findings show that hedge fund activism and auditors are complementary at strengthening corporate governance.