مدیریت درآمد و تخصصی شدن حسابرس در دوران پس از ساکس: بررسی صنعت بانکداری

This study examines the impact of auditor specialization on bank loan loss provisions for a large cross-section of US banks for the period 2002–2006. We find a positive relationship between earning (before provision) and loan loss provision, suggesting that bank managers use LLP to smooth earnings in the post-SOX period. However, this relationship is significantly moderated by audit industry expertise, providing strong evidence that industry specialization constrains income smoothing. In further analysis, we find some evidence that auditor specialization is more effective in reducing potentially incoming-increasing earnings management. Our results hold after controlling for self-selection bias and are robust to alternative measures of industry specialization. Overall, our findings support the conclusion that audit industry expertise plays an effective monitoring role in constraining management’s discretionary accounting choices.

Our study’s purpose is to evaluate the role of specialist auditors in constraining earnings management via loan loss provisions in the banking industry. Unlike most other industries, the banking industry is highly regulated and is subject to the scrutiny of various government agencies. Bank financial statements are reviewed by a number of people both internal and external to the bank (e.g., bank management, creditors and owners, banking analysts, and state and federal regulators) (Dahl et al., 1998). Despite extensive regulatory oversight, bank managers have considerable discretion in how they recognize and record the provision for loan losses. The majority of prior studies provide evidence that loan loss provisions are extensively used by bank managers to manipulate reported earnings.1 Consequently, users of a bank’s financial information likely rely on high-quality auditors that can provide crucial oversight in reviewing and attesting to management’s estimates, especially material ones such as loan loss provisions. Consistent with this view, a US General Accounting Office (GAO) study (GAO, 1991) states that independent financial audits can improve the reliability of financial statements by verifying whether banks are being truthful in their published financial reports, thereby reducing the public’s uncertainty about the banks’ financial health. Auditor industry specialization/expertise represents an important dimension of audit quality. A specialist’s knowledge of the industry is developed through extensive auditing experience, specialized staff training, and expensive investments in information technology. Relative to non-specialist auditors, this industry-specific knowledge enables specialist auditors to provide higher quality audit service to the clients by reducing information symmetry through their greater ability to detect material misstatements and constrain management’s discretionary behavior. Given that information uncertainty is greater in the banking industry relative to industrial firms due to the more complex nature of bank operations (Autore et al., 2009), auditor specialization may play an even more significant role in mitigating information asymmetry. However, Black (1990b) suggests that compared to federal or state regulators who represent the interest of the deposit insurer, auditors are more likely to know more about the accounting issues but less about the banking industry and current regulatory concerns. The subjectivity involved with valuing banks’ loan portfolios is a major area of concern.2 Auditors seem to have difficulty measuring amounts of loan losses (Moyer, 1990) and have been forced to reissue their reports because of findings of regulators (Black, 1990a). Hence, it comes down to an empirical question as to whether auditor industry specialization is similarly associated with earnings quality in the banking industry. We test our hypotheses using a sample of 1249 bank-year observations for the period 2002–2006. This was a period following the implementation of the Sarbanes–Oxley Act of 2002 (SOX) and preceding the recent financial crisis, and it was a period characterized by increasing regulatory scrutiny on auditing practices and the issuance of several new auditing standards. We focus on the post-SOX period for two reasons. First, recent research has found evidence of more conservative management and auditor behavior due to increased regulatory, investor, and media scrutiny and heightened legal liability.3 Therefore, including data from two distinct sample periods could potentially confound the analysis of the effect of auditor specialization on the financial reporting quality. Second, we believe that by focusing on a more recent period, the findings from this study can be more useful to interested parties, such as regulators and investors. We employ various measures of auditor specialization accepted in the extant literature to conduct our empirical tests. Our results show that US banks continue to smooth accounting earnings via loan loss provisions in the post-SOX period. More importantly, we find strong empirical evidence that auditor industry specialization plays an important role in constraining bank managers’ income smoothing behavior. In further analysis, we find that auditor specialization is more effective in reducing income-increasing earnings management. This result is consistent with the notion that auditor industry specialization leads to more conservative estimation of loan loss provisions, probably due to auditors adopting reporting conservatism and focusing more attention on incoming-increasing accruals than incoming-decreasing accruals. This research is timely and relevant. The recent financial/banking crisis highlights the importance of the auditor’s monitoring role in the banking industry. At this important time, investors are increasingly interested in information about the earnings quality of banks and the role of audit specialists in enhancing bank earnings quality. Our research provides valuable insights into whether industry expertise matters and whether it curtails earnings management in the banking industry. To the best of our knowledge, there are a limited number of prior and concurrent studies that examine the relation of income smoothing and audit quality in the banking industry. Kanagaretnam et al. (2009) document a higher market valuation of the discretionary component of loan loss provisions for banks audited by a specialist auditor, consistent with auditor expertise mitigating information asymmetry between bank managers and investors and enhancing the information conveyed by discretionary LLP. A concurrent paper by Kanagaretnam et al. (2010b) is closely related to this study. Using a sample of banks from 29 countries (the US not included), they find that auditor industry specialization moderate benchmark-beating behavior and constrain income-increasing earnings management in banks. Our study differs from theirs in two important ways. First, we focus on US banks drawn from a more recent time period. Second, while their study examines only the income-increasing managerial discretion, we explore the differential role of auditor specialization in mitigating earnings management for different types of discretionary provisioning behavior. Taken together, our results and those of the concurrent research in this area jointly present a fairly cohesive picture of the impact of auditor specialization on the quality of financial reporting. The collective evidence has important implications for financial regulators and others focusing on improved financial regulatory reform. If specialization limits bank managers’ ability to manage earnings, then at least regulators and others will have assurance that auditor expertise is important and plays a valuable role in the financial services industry. We organize the rest of the paper as follows. The next section discusses and develops our hypotheses regarding the impact of industry specialization on earnings management. Section 3 presents the sample selection, research design, variable measures, data, and models employed in testing our hypotheses. Section 4 discusses our results. Section 5 discusses our conclusions and the various limitations of our study.

With a $700+ billion bailout plan approved and a large majority of that reserved for the banking industry, it behooves the research community to examine the potential impact of auditor specialization on banks’ loan loss provision. Our study addresses whether industry specialization influences bank managers’ provisioning behavior. The literature shows that there are audit fee premiums associated with industry specialization (Craswell et al., 1995 and Francis et al., 2005). Stanley and DeZoort (2007) provide evidence that industry specialization and audit fees are inversely related to the likelihood of restatement. Are these fee premiums worth it or are they squandered shareholder dollars? If these questions are not answered, then the real value of auditor specialists may be left unanswered. We examine four variant measures of auditor industry specialization: two based on audit fees, one on client share, and one by exclusively coding PWC or KPMG as a specialist. We find support for our hypothesis that earnings (before the loan loss provision) is significantly and positively associated with loan loss provision, suggesting that auditor specialization attenuates income smoothing. In addition, we provide some evidence that auditor specialization is more effective in constraining the type of earnings management that is more likely to result in incoming-increasing provisions. Overall, our findings support the conclusion that audit industry expertise provides more efficient monitoring of management’s discretionary accounting choices. This study has a number of limitations, and several caveats should be highlighted in interpreting these findings. First, the maintained hypothesis of this research is that there are causal relationships between industry specialization and loan loss provision levels and the various control variables studied. Although we attempt to explicitly control for self-selection bias through the use of a propensity score matched pair approach, our ability to infer causality between auditor specialization and earnings management via LLP is limited. Second, we do not measure specific ways auditors perform their specialization tasks. Rather we use proxies to measure auditor specialization that is multidimensional and inherently unobservable. Thus, the potential for measurement error is a limitation of our study as well as previous studies in this area. Finally, we measure our industry specialization on a national market share level and do not capture local expertise. The city-level distinction may be more germane to non-Big 4 auditors as argued in Balsam et al. (2003). However, after controlling for national-level industry specialization, we did not find any significant relation between LLP and city-specific industry expertise. Further research using more refined measures is warranted to explore the differential impact of national and local level auditor specialization on the financial reporting quality in the banking industry.