Banking (in)stability: Are Auditors a Cause or a Cure?

• In Event: The Effect of Audit Quality

Abstract

Ensuring the stability of the financial system is a top goal for regulators and policymakers. Despite the critical role depositors play in financial system stability, research on the importance of financial reporting information and auditor assurance to depositors is largely absent from accounting literature. In this study we examine how auditors influence depositor behavior by increasing monitoring efficiency, and also by acting as a channel to spread bank run contagion in the event of a bank failure. Using a sample of audited and unaudited banks, we find that depositors significantly change their response to financial statement information in the presence of an auditor or trusted auditor. We also find that when the reputation of an auditor is damaged through association with a bank failure, other clients of the failed bank’s auditor experience a decrease in uninsured deposits and an increased likelihood of large uninsured deposit withdrawal. Overall, our findings are consistent with depositors valuing the presence and reputation of the auditor and demonstrate that an auditor can improve financial system stability by facilitating more efficient monitoring, but can also contribute to financial system instability by acting as a channel to spread bank run contagion.

Authors

• Matthew James Beck, Michigan State University

• Allison Nicoletti, University of Pennsylvania

• Sarah Barron Stuber, Michigan State University