Do Bank Regulation and Supervision Displace Bank Auditing?

Abstract

We hypothesize that bank regulatory and supervisory activities substitute for bank auditing activities, providing auditors with incentives to expend less effort on audits of banks than on audits of similar firms not subject to regulation and supervision. We show that banks exhibit fewer internal control and accounting problems, as measured by the frequencies of disclosed material internal control weaknesses and financial statement restatements, than do similar firms. We show that auditors expend less effort, as indicated by lower audit fees and shorter audit report lags, in audits of banks than in audits of similar firms, more so when bank regulation and supervision are more intense. Lastly, we show that banks are more likely than similar firms to exhibit two types of earnings management that are of minor concern to bank regulators and supervisors but have capital market consequences and so should concern auditors: more frequent small positive earnings changes and longer strings of earnings increases. Prior research shows that these types of earnings management have capital market consequences, which suggests they may lead to reduced market discipline over banks. We expect these results to be of interest to bank and auditing policymakers.

The impact of the precision of accounting standards on the expanded auditor’s report in the European Union

“…In this context, we would expect a higher probability of KAM disclosure due to the higher risk associated with these audits. Nevertheless, as financial institutions, and likewise utilities, are highly-regulated sectors with a possible joint effect between regulators and auditors in firm's monitoring, which may reduce risk-taking (Ghosh, Jarva, & Ryan, 2017), we expect firms in these two industries (INDFI, INDU) to have fewer KAM disclosures.…”

“…Despite the higher complexity of firms in the financial and utilities sector, we expect firms in these two industries (INDFI, INDU) to have more readable auditor's reports. As these companies operate in a regulated sector, there is a possible joint effect between regulators and auditors in the monitoring of firms, resulting in a positive effect on the reduction of risk-taking (Ghosh et al, 2017).…”

What matters in disclosures of key audit matters: Evidence from Europe

“…Because of the role of regulators and supervisors, auditors need to perform less extensive audit work than do auditors of other firms and, therefore, tend to disclose fewer KAMs. Ghosh, Jarva, and Ryan () show that the regulation and supervision of banks provide auditors with incentives to reduce their effort on the audits of banks.…”

Do Strict Regulators Increase the Transparency of Banks?

“…However, they are also very infrequent and only observable for the subsample of publicly listed banks. In a sample of publicly listed banks, Ghosh, Jarva, and Ryan [] report that only approximately 0.7% of bank‐years restate prior years' restatements.…”