Auditor Conservatism and Banks' Measurement Uncertainty during the Financial Crisis

Abstract

During the most recent financial crisis, the economic difficulties, along with potentially high uncertainties associated with fair value estimates, increased the audit risks for bank auditors. We analyze a sample of US public banks during the crisis (2008–09) and after the crisis (2010–11), and provide contrasting evidence concerning auditors' role in conservative financial reporting (proxied by higher discretionary loan loss provisions). Specifically, we document a significant positive association between discretionary loan loss provisions and the role of auditors (proxied by higher amounts of audit fees and abnormal audit fees) during the crisis. However, the positive association disappears following the financial crisis. Similarly, we document that during the crisis, auditors are less likely to issue unmodified audit opinions to banks that subsequently filed for bankruptcy. Thus, our evidence is consistent with elevated auditor conservatism for the sample banks during the financial crisis. Our evidence also suggests that bank auditors raise fees more to maintain accounting quality than to price protect from aggressive accounting choices.