Bank earnings quality and auditor industry specialization during the global financial crisis

RESEARCH OBJECTIVES The purpose of the present study is to examine if bank earnings quality declined during the global financial crisis compared to the period before the crisis and whether industry specialist auditors were better able to constrain the expected earnings quality decline than non-specialist auditors. I use the absolute level of discretionary loan loss provisions as the proxy of earnings quality. Previous research has documented that bank managers use loan loss provisions to manipulate earnings. Furthermore, it has been shown that industry specialist auditors enhance financial reporting quality. However, to my knowledge this is the first study to examine the combined effect of the global financial crisis and auditor industry specialization on bank earnings quality. DATA AND METHODOLOGY The present study examines publicly traded American bank holding companies. The sample consists of 2110 bank year observations and 482 bank holding companies from the period 2004-2009. I gather the sample data from Compustat Bank Annual, Audit Analytics and Bank Regulatory Bank Holding Companies data files. The main research method is multiple linear regression analysis, which is conducted by using SPSS software. RESULTS I find a positive relationship between the absolute level of discretionary loan loss provisions and the global financial crisis, suggesting that the crisis increased earnings management and decreased earnings quality compared to the period before the crisis. Results of additional analyses suggest that overstating loan loss provisions caused the decline in bank earnings quality during the crisis. My results do not give any statistically significant evidence on the ability of industry specialist auditors to constrain earnings quality decline during the global financial crisis better than non-specialist auditors