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1. Introduction
In this study, we examine how audit client importance affects future bank-specific risk and systemic risk in the banking industry using a sample of US commercial banks. The 2008–2009 financial crisis arouses research interest in the role of external bank auditors in bank risk and financial crises. Regulators, investors and researchers expect bank auditors to improve audit quality and play a critical role in constraining individual bank risk and systemic risk in the banking sector. For example, the Basel Committee on Banking Supervision (BCBS) (2014) states, “External auditors of banks can play an important role in contributing to financial stability when they deliver quality bank audits which foster market confidence in banks’ financial statements.” In contrast, critics blame that auditors of financial institutions fail to deliver quality audits in the period leading to the financial crisis, and their impaired audit quality contributed to the recent financial crisis. During the 2008–2009 financial crisis, many financial institutions either collapsed or got bailed out shortly after they received clean audit opinions that failed to give early warning signals. For example, Bear Stearns received an unqualified audit opinion for fiscal year 2007, yet it went bankrupt soon after its financial problems became exposed in 2008 (SEC, 2008).
Doogar et al. (2015) provide evidence that auditors do understand the impact of heightened risk of the 2008–2009 crisis for bank clients, and respond to the macroeconomic shocks and systemic risk exposures of bank clients by setting higher audit fees in the period leading to the 2008–2009 crisis. However, do auditors take further actions in their audit process to improve their audit quality, such that future bank risk and systemic risk exposures are constrained, especially for large and important banks? Little research systematically explores this research question. The only exception is Jin et al. (2011), who provide limited evidence that banks audited by Big-N auditors and auditors with industry expertise have lower failure risk during the financial crisis. However, that study does not focus on economically important banks, sector-wide systemic risk or the non-crisis period. To provide further evidence regarding the controversy about the role of bank auditors in financial crises, this study is motivated to systematically examine this research question. Examining this research question is especially important for...