Mandatory Audit Regulation for Banks: An Empirical Evaluation of Its Effects

Abstract

One of the most striking characteristics of the securities industry is that it is very heavily regulated, especially with respect to information production. There are at least three identifiable levels of intervention dealing with the production of financial information: first, corporations are required to provide certain types of information and some minimum amount of information; second, the financial information, for the most part, has to be certified (audited); and finally, those who certify the statements have themselves to be licensed. All these regulations are instituted for the alleged protection of the investing public. This study will examine the second type of intervention mentioned above, namely, a mandatory audit requirement. It will specifically examine the effects of a particular Securities and Exchange Commission (SEC) requirement that mandates banks reporting to them to have their This paper examines the effects on stock returns of the mandatory audit regulation imposed on banks by the Securities and Exchange Commission in 1971. It is found that this imposition affected the stock returns negatively for those banks that did not voluntarily choose to employ external audits prior to the regulation. This is contrary to claims that such a mandatory regulation would be beneficial. The methodology employed is based on the familiar market model and the Gonedes approach.