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    An Empirical Analysis of Auditor Independence in the Banking...
    research summary posted March 19, 2013 by James L Fuehrmeyer, tagged 04.0 Independence and Ethics, 04.02 Impact of Fees on Decisions by Auditors & Management, 04.03 Non-Audit Services 
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    Title:
    An Empirical Analysis of Auditor Independence in the Banking Industry
    Practical Implications:

    The results suggest that fees paid to auditors, even for non-audit services, can potentially threaten auditor independence, particularly among banks that are not subject to the same level of regulatory scrutiny as large banks.

    Citation:

    Kanagaretnam, K., G. V. Krishnan, and G. J. Lobo. 2010. An Empirical Analysis of Auditor Independence in the Banking Industry. The Accounting Review 85 (6): 2011-2046.

    Keywords:
    auditor independence; earnings management; auditor fees; bank loan
    Purpose of the Study:

    Auditor independence is vital to maintaining public confidence in capital markets and to the integrity of corporate financial statements. The objective of this study is to examine auditor independence in the banking industry.

    • The study provides evidence on the relation between fees paid to auditors of banks and the extent of earnings management via loan loss provisions (LLPs).
    • The study is timely and relevant given the recent banking crisis and that governments around the world are contemplating new banking regulations.
    • The research informs policymakers on the relationship that existed between fees paid to auditors and the extent of earnings management in banks prior to the current banking crisis.
    • Authors examine difference between large and small firms that face different levels of regulation. Small firms are not subject to regulation under the Federal Deposit Insurance Corporation Improvement Act (FICIA) of 1991.
    Design/Method/ Approach:

    The authors collected 1,740 bank-year observations over the years 2000–2006. The authors determine abnormal LLPs and examine the association between abnormal LLPs and unexplained total fees and unexplained non-audit fees. They then examine whether the association is different depending on whether the bank is small (total assets of less than $500 million or less than $1 billion, effective 2005, or non-accelerated filers under Section 404 of Sarbanes-Oxley Act, effective 2004) or large.

    Findings:
    • For large banks, there is no relationship between abnormal LLPs and unexplained total fees or unexplained non-audit fees.
    • For small banks, higher unexplained total fees and unexplained non-audit fees are positively associated with income-increasing earnings management through LLPs. Higher unexplained total fees and unexplained non-audit fees are negatively associated with income-decreasing earnings management through LLPs. These two results provide evidence that banks that pay higher audit fees engage in more earnings management.