Author(s): Sarah Feltus*
Hedge funds have grown rapidly in the last two decades, from managing assets worth approximately $600 billion in 2003 to over $3 trillion in 2017 and $4 trillion by the end of 2024. As hedge funds themselves have grown, so too have concerns about their involvement with publicly traded companies and their effect on various stakeholders and the economy. Although Critics claim that hedge fund activism creates a short-term focus, shifting funds out of expansion and research and development and into distributions to shareholders, proponents argue that hedge fund activism helps boards overcome management incompetence and counter passive investors. Academic research is mixed on the long-term effects of hedge fund activism and few studies have examined the relationship between hedge fund ownership and the external audit process. The purpose of this study is to investigate whether hedge fund ownership affects auditor- client contracting. Specifically, the study examines the relationships between hedge fund ownership and (1) audit fees and (2) audit lag. Although Critics claim that hedge fund activism creates a short-term focus, shifting funds out of expansion and research and development and into distributions to shareholders, proponents argue that hedge fund activism helps boards overcome management incompetence and counter passive investors. Academic research is mixed on the long-term effects of hedge fund activism and few studies have examined the relationship between hedge fund ownership and the external audit process. The results show that hedge fund ownership (both the number of hedge fund owners and the percentage owned) has a highly significant, negative relationship with audit lag. This finding indicates auditors perceive clients with hedge fund owners to decrease audit risk. Results also show that hedge funds increase audit fees. In additional analysis, however, this positive association is shown to be driven by increased audit effort, not the presence of hedge funds. These results suggest that hedge fund owners decrease perceived audit risk and are willing to pay higher audit fees for higher quality audits.