Do Bank Regulation and Supervision Substitute for Bank Auditing?
58 Pages Posted: 28 Sep 2017 Last revised: 5 May 2018
Date Written: April 27, 2018
We hypothesize that bank regulation and supervision reduce inherent and control risk in audits of banks, thereby enabling auditors to expend less effort on these audits than on audits of control firms that are economically similar but subject to less or no regulation and supervision. We show that banks exhibit fewer internal control and accounting problems, as indicated by material internal control weaknesses and financial statement restatements, than do control firms. We show that auditors expend less effort, as indicated by lower audit fees, in audits of banks than in audits of control firms, more so when bank regulation and supervision are more intense. Lastly, we show that banks are more likely than control firms to exhibit two types of earnings management that are of minor concern to bank regulators and supervisors but are known to have capital market consequences: more frequent small positive earnings changes and longer strings of earnings increases. These results suggest that reduced audit effort yields lower market discipline over banks.
Keywords: Banks, auditing, regulation, supervision, internal control, accounting
JEL Classification: G21, G23, G28, M41, M42
Suggested Citation: Suggested Citation