The Effect of Auditor-Provided Regulatory Advisory Services on Financial Reporting Quality: Evidence from the Dodd-Frank Act

• In Event: Financial Reporting Quality & Auditing

Abstract

In 2010, the Dodd-Frank Act increased regulatory requirements to strengthen the safety and soundness of the financial system. These requirements resulted in banks investing significantly to develop regulatory models, improve internal reporting, and create operational monitoring to meet the new guidelines. This paper examines whether assistance by the bank’s external auditor with meeting the new regulatory guidelines (regulatory advisory services) influences financial reporting quality, measured as the validity of the loan-loss provision, earnings persistence, and benchmark-beating. Using a difference-in-differences design, we find that banks hiring their external auditor to provide regulatory advisory services are associated with a decline in financial reporting quality. Further, this relation is more pronounced for banks experiencing greater regulatory pressure and for banks with less effective audit committees. Taken together, our results are consistent with regulator concerns that financial reporting quality diminishes when external auditors also serve in an advisory capacity.

Authors

• Hailey B Ballew, The Ohio State University

• Amy Genson Sheneman, The Ohio State University