Industry-expert auditors and investor valuations in regulated industries: evidence from banking

We propose that regulation increases the demand for industry-expert auditors. We hypothesize that this increase in demand will be reflected in the degree of reliance investors place on financial information certified by industry-expert auditors. We evaluate the return-earnings relation for regulated banks that choose industry-expert and non-industry-expert auditors. By enhancing the credibility of the financial statements, industry-expert auditors potentially strengthen the link between earnings and returns even in a regulated environment. The results suggest that the choice of an expert-auditor favorably affects investor valuations of the banks used in the sample. Earnings explains more of the variation of returns when the earnings numbers are certified by expert versus non-expert auditors after controlling for the effects of regulatory attention.
INTRODUCTION Regulation can modify the nature of auditing. Regulation provides auditors with additional roles, roles that are better fulfilled by auditors who specialize in developing and understanding the subtleties and [...]