Auditor Litigation Risk and the Number of Institutional Investors

We investigate whether auditors are sensitive to litigation risk related specifically to having greater numbers of institutional investors that hold the common stock of a given client. Our findings suggest that audit fees are higher when the number of institutional investors holding stock in the company is greater. Additional tests corroborate our inference that the association between audit fees and the number of institutional investors is related to litigation risk. The importance of improving our understanding of auditors' sensitivity to factors that increase litigation exposure is highlighted by the number and magnitude of lawsuits filed against auditors relating to the audits of public clients.