Internal Control Quality and Bank Risk-Taking and Performance

AUDITING: A Journal of Practice & Theory, Vol. 40 (2), pp. 49–84, May 2021

55 Pages Posted: 3 Jan 2019 Last revised: 2 Sep 2021

See all articles by Matthew Baugh

Matthew Baugh

Arizona State University (ASU) - School of Accountancy

Matthew Ege

Texas A&M University - Department of Accounting

Christopher G. Yust

Texas A&M University

Date Written: May 1, 2021

Abstract

Using a sample of bank-years from 2005 to 2017, we examine the effect of internal control quality on future risk-taking and performance. We find that banks that disclose a material weakness in internal controls have higher risk-taking and worse performance in the future, including having a higher (lower) likelihood of experiencing large losses (gains). These findings suggest that weak controls increase (reduce) downside (upside) risk-taking or conversely that strong controls increase (reduce) upside (downside) risk-taking. Path analyses suggest that 22.3 to 43.7 percent of the effect of internal control quality on future performance is through risk-taking. Additionally, material weaknesses are negatively associated with total asset, loan, interest income, and non-interest income growth, suggesting that internal control quality affects both core and non-core activities of banks. Overall, results suggest that strong internal controls improve bank risk-taking, in part through asymmetrically reducing downside risk-taking while facilitating upside risk-taking, ultimately improving bank performance.

Keywords: bank performance; bank risk-taking; internal control quality

JEL Classification: G01; G21; G28; M41; M48

Suggested Citation

Baugh, Matthew and Ege, Matthew and Yust, Christopher G., Internal Control Quality and Bank Risk-Taking and Performance (May 1, 2021). AUDITING: A Journal of Practice & Theory, Vol. 40 (2), pp. 49–84, May 2021, Available at SSRN: https://ssrn.com/abstract=3302936 or http://dx.doi.org/10.2139/ssrn.3302936

Matthew Baugh

Arizona State University (ASU) - School of Accountancy ( email )

Tempe, AZ 85287
United States

Matthew Ege

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States

Christopher G. Yust (Contact Author)

Texas A&M University ( email )

430 Wehner
College Station, TX 77843-4353
United States
979.845.3439 (Phone)

HOME PAGE: http://www.christopheryust.com

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