Bank Regulation/Supervision and Bank Auditing

Abstract

We investigate how overlapping activities of bank regulators and supervisors and bank auditors influence banks’ internal control quality, auditor-client contracting (audit fees and audit effort), and financial statement reliability. Using material weaknesses in internal controls as a proxy for internal control quality, we find that banks exhibit fewer internal control problems than do nonbanks. Using audit fees, earnings announcement lags and audit report lags as alternative proxies for audit effort, we find that auditors expend less effort in audits of banks than in audits of nonbanks. Despite the lower audit effort, we find that banks report fewer and less severe restatements of prior period financial statements than do nonbanks, suggesting that the aggregate efforts of bank regulators/supervisors and bank auditors generate more reliable financial reporting by banks. A notable implication of our study is that bank regulation and supervision alter the auditor-client contracting equilibrium, with a notable benefit being an increase in banks’ financial reporting quality.

Keywords: Banks, auditing, audit effort, regulation, supervision, internal controls, material misstatements, accounting

JEL Classification: G21, G23, G28, M41, M42