Audit Fees in Global Systemically Important Banks and Banking Supervisory Power

In 2011, the largest banks were designated as Global Systemically Important Banks (GSIBs) by the Financial Stability Board. While these banks face closer supervision and additional constraints, they also benefit from an implicit guarantee from their governments. The changed environment for these very large banks has likely altered their managers’ incentives for opportunistic accounting choices, and consequently the risk of material misstatement (RMM) as well as the litigation risk for auditors. In this study, we examine the consequences of this change for auditors of GSIBs. More precisely, we investigate the audit fees paid by European banks designated as GSIBs, and whether the change in audit fees following designation is related to the power of the country’s banking supervisor. We find that, pre-2011, GSIBs were paying relatively higher audit fees in countries with a more powerful banking supervisor compared to other banks. However, auditors did not significantly increase their audit fees for banks designated as GSIBs in these countries, plausibly because the corporate governance of these GSIBs improved after 2011, which led to a better monitoring environment and therefore to a reduction of the RMM. Furthermore, we expect the marginal increase in supervisory attention towards GSIBs to be lower in these countries, thus mitigating the effect of a potential increase in litigation risk for auditors. Nonetheless, audit fees significantly increased after 2011 for GSIBs from countries with a less powerful banking supervisor. This increase in audit fees was accompanied by an improvement of the financial reporting quality of these banks. Overall, we conclude that while the GSIB regulation had some economic consequences for the auditor-client contracting equilibrium, these consequences are sensitive to the power of the country’s banking supervisor