Is the Market Valuation of Banks’ Loan Loss Provision Conditional on Auditor Reputation?

Abstract

We examine how auditor reputation conditions the market valuation of banks’ loan loss provision (LLP). The inherent uncertainty associated with and discretion permitted in estimating the LLP contributes to information asymmetry. The auditor’s certification and monitoring roles influence firm value by mitigating this information asymmetry. We examine two aspects of auditor reputation, auditor type (Big 5 vs. non-Big 5) and auditor expertise, in the banking industry. We find a significant, positive association between the discretionary component of LLP and stock return for banks audited by the Big 5 auditors. Further analysis indicates that auditor industry expertise and not auditor type drives this significant, positive association. Overall, our results are consistent with auditor reputation (expertise in the banking industry) mitigating information asymmetry between bank managers and investors and enhancing the informational value of discretionary loan loss provision.

Keywords: Auditor reputation, Auditor Expertise, Audit Quality, Loan Loss Provision, Market Valuation, Signaling

JEL Classification: G14, G21, M41, M4