The Effect of Insured Liabilities on the Demand for External Audits: The Case of Privately-Held U.S. Banks

Abstract

This study examines the effect of the government provided insurance on bank debt on the voluntary audit choice made by privately held banks in the United States. By using data available from banking regulators, we are able to overcome data limitations of prior research on voluntary demand for auditing services. Banks have the unique feature of insurance on customer deposits that is provided by the Federal Deposit Insurance Corporation, and these insured customer deposits comprise a significant portion of the debt of most banks. Consistent with prior research we find that the voluntary choice to be audited is positively related to agency costs as measured by the size of bank assets. Prior research has found a mixed association between the demand for auditing and debt, and our results may shed some light on this issue. Our results show a negative association between a bank’s insured deposits and the choice to be audited, but (consistent with prior literature) a positive association with uninsured liabilities. In addition, we also hypothesize and find that the bank’s voluntary audit choice is positively related to the bank’s growth rate and related to the bank’s primary federal regulator. These findings may have policy implications at a time when changes to banking regulation are being considered.