The Effect of Growth on Financial Reporting and Audit Quality: Evidence from Economic Shocks to Banks

• In Event: External Factors Influencing Audit Quality

Abstract

Periods of rapid growth caused by shocks to a firm’s operating environment represent a potential threat to financial reporting quality by presenting challenges to both the firm and its auditor. Despite the ubiquity of economic changes little is known of the extent to which these changes affect financial reporting and audit quality. Using exogenous economic shocks to local banks from oil and natural gas discovery and extraction, I find that financial reporting quality, measured by loan loss estimate quality, is lower in a period of rapid bank growth due to management’s underreaction to the positive economic shock. I also find that auditors with a combination of both task-specific and industry-specific expertise are more successful in mitigating this deterioration compared to auditors with general, Big 4 or industry-specific expertise alone. The findings suggest that a combination of industry and task-specific auditor expertise is needed to combat deterioration in financial reporting quality resulting from a positive economic shock.

Author

• Sarah B Stuber, Michigan State University