The effect of insured liabilities on the demand for external audits: The case of privately‐held United States banks

Abstract

We examine the relationship between government insurance for bank deposits and bank management's voluntary audit choice for a set of privately‐held U.S. banks. Unlikely publicly‐traded banks, U.S. regulations do not require private banks to obtain annual audits. However, all U.S. banks have the feature of insurance on customer deposits that is provided by the Federal Deposit Insurance Corporation—these insured customer deposits comprise a significant portion of the debt of most banks. Consistent with prior research we find that the voluntary choice to be audited is positively related to agency costs as measured by the size of bank assets. Our results show a negative association between a bank's insured deposits and the choice to be audited but (consistent with prior literature) a positive association with uninsured liabilities. In addition, we hypothesize and find that the bank's voluntary audit choice is positively related to the bank's growth rate and related to the bank's primary federal regulator. Taken together, these findings are consistent with the notion that audits create value primarily for uninsured depositors and have implications for bank managers, their customers, and regulators.