Ownership Structure and the Demand for Auditor Quality

Abstract

Purpose: This paper investigates the effect that ownership structure (public vs. private) has on the demand for high-quality auditors, specifically in the U.S. banking industry. Design/Methodology/Approach: We predict that public banks are more likely to hire a high-quality auditor than private banks and pay a higher audit fee premium for that high-quality auditor (due to higher agency costs, more demand for financial information and higher litigation risk). We analyze 2008-2014 banking data from the Federal Reserve using probit and OLS regression analysis to examine if there is a higher probability that public banks choose higher quality auditors and pay higher audit fees when they do so. Findings: Our results show that private banks are less likely to hire Big 4 auditors and industry-expert auditors than public banks. We also find that both private and public banks pay higher audit fees for Big 4 and industry-expert auditors, and that public banks pay a higher premium for Big 4 auditors and industry experts than private banks. Research Limitations/Implications: Our findings may not be full generalizable to other types of firms, as banking is a heavily regulated and complex industry. However, inferences from our study may be generalizable to other similar industries such as insurance or healthcare. Practical Implications: The results of this paper imply that public and private banks have differing priorities when hiring their financial statement auditor. This may be of interest to investors and auditing regulators. Social Implications: The findings of this paper underscore the value of hiring an industry-expert auditor in an industry that is highly complex and regulated. This may be of interest to managers and policymakers. Originality/Value: Due to data restrictions, the emphasis of prior literature on the banking industry has been on public banks. Our study is the first to analyze the differences between public and private banks’ demand for audit services.