Distracted Institutional Investors and Audit Risk

Abstract

We use a newly developed institutional investor distraction measure (Kempf, Manconi, & Spalt, 2016) to examine whether auditors charge higher audit fees and exert higher efforts when their clients’ institutional investors temporarily reduce their monitoring activities. We find that audit fees and audit report lags increase significantly during periods when institutional investors are distracted. This effect is stronger when dedicated institutional investors are distracted. We further show that the positive association between the investor distraction measure and audit risk measures declines in the post-Sarbanes–Oxley Act period. Collectively, our results suggest that institutional shareholders monitoring activities benefits auditors by reducing audit risks. This paper also shows that the negative effect of investors’ limited attentions on corporate monitoring can to some extent be mitigated by auditors.

Keywords: institutional investor distraction; audit risk; audit fee; audit lag

JEL Classification: G23, M4