The Governance Role of Auditors: Evidence from Derivative Lawsuits

67 Pages Posted: 28 May 2021 Last revised: 19 Jul 2021

See all articles by Susan Shu

Susan Shu

Boston College - Carroll School of Management

Xu Li

The University of Hong Kong

Qian Xin

School of Economics and Management, Harbin Institute of Technology Shen Zhen

Date Written: May 26, 2021

Abstract

This paper examines whether external auditors play a unique governance role distinct from other mechanisms of corporate governance. We exploit the staggered adoptions of the Universal Demand (UD) laws by U.S states, which have been shown to result in the decline of various corporate governance mechanisms. We examine whether auditors step up their monitoring when outside shareholders place a greater demand on external monitoring, yet other governance mechanisms decline. We find that external auditors are more likely to issue going-concern opinions to financially distressed firms after their incorporation states have adopted the UD laws. Further, the increased propensity to issue going-concern opinions is driven by auditors’ reputation and litigation concerns. The effect is stronger when alternative governance mechanisms are weak, and it is not attenuated by auditors’ financial ties to clients. We also find evidence of greater auditor monitoring after the passage of UD laws using two alternative outcomes, i.e., the reporting of internal control weakness and the length of audit reporting lag. Overall, our findings suggest the unique monitoring role of external auditors as they step up their oversight of the audited firms in the lapse of other monitors.

Keywords: Auditing; Value of Auditing; Going Concern, Corporate Governance; Derivative Lawsuits

Suggested Citation

Shu, Susan and Li, Xu and Xin, Qian, The Governance Role of Auditors: Evidence from Derivative Lawsuits (May 26, 2021). Available at SSRN: https://ssrn.com/abstract=3855088 or http://dx.doi.org/10.2139/ssrn.3855088

Susan Shu (Contact Author)

Boston College - Carroll School of Management ( email )

Boston College
140 Commonwealth Ave.
Chestnut Hill, MA 02167
United States
617-552-1759 (Phone)

Xu Li

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Qian Xin

School of Economics and Management, Harbin Institute of Technology Shen Zhen ( email )

University Town
Nand District
Shenzhen, Guangdong
China

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