The effect of insured liabilities on the demand for external audits: The case of privately‐held United States banks

AuthorBrad J. Reed,Jamie Hoelscher,Gregory Sierra
Published date01 July 2019
Date01 July 2019
The effect of insured liabilities on the demand for external audits:
The case of privately-held United States banks
Jamie Hoelscher | Brad J. Reed | Gregory Sierra
Department of Accounting, Southern Illinois
University Edwardsville, Edwardsville,
Gregory Sierra, Department of Accounting,
Southern Illinois University Edwardsville,
Campus Box 1104, Edwardsville, IL 62026.
We examine the relationship between government insurance for bank deposits and
bank management's voluntary audit choice for a set of privately-held U.S. banks.
Unlikely publicly-traded banks, U.S. regulations do not require pr ivate banks to
obtain annual audits. However, all U.S. banks have the feature of insurance on cus-
tomer deposits that is provided by the Federal Deposit Insurance Corporationthese
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 posi-
tively related to agency costs asmeasured by the size of bank assets. 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 hypothesize and find that the bank's voluntary audit choice is posi-
tively related to the bank's growth rate and related to the bank's primary federal regu-
lator. Taken together, these findings are consistent with the notion that audits create
value primarily for uninsured depositors and have implications for bank managers,
their customers, and regulators.
audit, banking, deposit insurance, regulation, voluntary audit choice
We extend the voluntary audit demand literature by examining
the effect of deposit insurance on the demand for external
audits. Prior research has investigated the demand for auditing
using an agency cost framework and has demonstrated a posi-
tive association between increased leverage and increased pro-
pensity to demand external audit. Menon and Williams (1994)
hypothesize that external audit serves as insurance for creditors.
Using publicly available data, we investigate the voluntary
demand for auditing services in the presence of insured liabili-
ties and explore whether actual insurance for creditors attenu-
ates audit demand.
We overcome data limitations in prior literature due to small
sample sizes. Because public U.S. companies are required to
be audited, the voluntary audit literature has often used smaller
samples of private companies. Limited data on private
companies can and perhaps has hindered more research into
voluntary audit demand. By studying private U.S. banks we
overcome research limitations due to limited numbers of
observations and time span. All banks in the United States are
required to file Call reports with their banking regulator. Call
reports contain audit choice and financial statement informa-
tion prepared in accordance with generally accepted account-
ing principles (GAAP). The data cover thousands of banks
over more than 20 years. In addition to providing financial
information on the Call report, banks indicate whether finan-
cial statements are audited.
One characteristic unique to banks is the insurance pro-
vided by the Federal Deposit Insurance Corporation (FDIC)
on the bank's deposits. We use this feature of bank capital
structure to examine the effect of insured liabilities versus
Received: 30 March 2019 Accepted: 15 April 2019
DOI: 10.1002/jcaf.22392
8© 2019 Wiley Periodicals, Inc. J Corp Acct Fin. 2019;

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