The Impact of Credit Market Development on Auditor Choice: Evidence from Banking Deregulation

Abstract

Exploiting the staggered state-level adoption of the Riegle-Neal Interstate Banking and Branching Efficiency Act (IBBEA), we examine whether and how banking deregulation affects firms’ auditor choices. We find that an exogenous increase in the degree of interstate branch banking deregulation leads to a reduction in firms’ propensity to engage Big N or industry expert auditors. In cross-sectional analyses, we further find that the negative effect of banking deregulation on firms’ auditor choices is more pronounced among firms with greater dependence on external financing as well as firms headquartered in the states with less-sophisticated local banks prior to deregulation and more-sophisticated entering banks following deregulation. Such evidence is consistent with banking deregulation exerting its effect on firms’ auditor choices through two underlying channels —firms’ increased access to bank credit and banks’ strengthened monitoring of firms. Our study sheds light on how the infrastructure of the U.S. credit market shapes firms’ auditor-choice decisions and provides evidence supporting the idea that auditors can serve as a governance substitute for weaker institutions.

Keywords: Auditor choice; Banking and branching deregulation; Credit market development; Corporate governance.

JEL Classification: G21, M42, G30, K22.