Universal Demand Laws and Stakeholders: Evidence from the Auditor's Perspective

Abstract

This study analyzes the impact of universal demand (UD) laws, which limit shareholders’ ability to initiate derivative litigation against firms and auditors, on external auditor behavior. After confirming that UD laws reduced the likelihood for clients (auditors) to be named in this litigation, we find that firms incorporated in states that adopted UD laws have lower increases in audit fees than non-adopting states. These results are magnified for firms when client (auditor) bargaining power is high (low), but not for those actively engaged in derivative litigation, suggesting that auditors are able to actively distinguish which firms benefit from lower derivative litigation risk. We do not find evidence that reporting quality declines as a result of these reduced fees. Our results suggest that UD laws relieved unnecessary burdens imposed by excessive derivative litigation on firms and auditors.

Keywords: Audit fees, derivative litigation, financial reporting quality, audit quality, litigation risk, universal demand law