Top

Review of Quantitative Finance and Accounting

Published in:

07-08-2020 | Original Research

Auditor response to changing risk: money market funds during the financial crisis

Authors: Kyle D. Allen, Drew B. Winters

Published in: Review of Quantitative Finance and Accounting | Issue 3/2021

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

Audits provide monitoring for investors. The collapse of markets across the financial crisis made assets more difficult to value, which increased risk for auditors. The money markets were at the center of the financial crisis increasing audit engagement risk on money market funds, which at the time of the crisis were highly opaque. Measuring the response to increased engagement risk with audit fees, this study finds that auditors increase their fees for the riskiest class of funds. However, no evidence was found that audit fees increased as funds increased their holdings in the riskiest class of securities.

previous article Lottery-type stocks and corporate strategies at the turn of the month

next article Revisiting disposition effect and momentum: a quantile regression perspective

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Available only for authorised users

The weighted average maturity (WAM in Table 1) is less than 45 days.

Anderson and Gascon (2009) note that heightened financial market uncertainty caused lenders to shift away from CP and into default-free securities. Commercial paper outstanding was $2.2 trillion in July 2007 at the beginning of the crisis. Commercial paper outstanding was $1.2 in December 2009 at the end of the crisis.

See Xu et al. (2013), Desai et al. (2016) and Zhang et al. (2011).

See Sikka (2009).

The PCAOB is a private-sector not-for-profit corporation created by the Sarbanes–Oxley act of 2002 to oversee the audits of public companies and further the public interest of accurate and independent audit reports.

Specifically, he testified on April 6, 2011 before the Senate Committee on Banking, Housing and Urban Affairs, Subcommittee on Securities, Insurance, and Investment.

SFAS 157 was issued September 2006 and began effective for fiscal year-ends after November 15, 2007.

Bell and Griffin (2012) suggest auditors face significant challenges and risks when auditing high-uncertainty fair value estimates.

Robinson et al. (2018) find that managerial discretion may have distorted values of level 3 assets held by banks.

Ball (2009) suggests that the financial crisis was the first big test for auditors under Sarbanes–Oxley.

Doty (2011) notes deficiencies related to insufficient evidence from auditors when using third party pricing sources to value financial instruments.

It is possible that a recession can drive audit fees down while maintaining quality. However, empirical research suggests this is difficult to do in practice (Ettredge et al. 2014a, b; Asthana and Boone 2012; Blankley et al. 2012).

Goldie et al. (2018) identify PWC as an audit specialist in bond mutual funds. They find higher audit fees for bond funds associated with PWC audits. Their sample period is 2005 through 2009, which includes the financial crisis.

Doogar et al. (2015) suggests auditors had the ability to recognize changes in risk, but that limitations in regulations may have prevented them from addressing it in an appropriate manner.

MMFs typically invest in the wholesale market, which means large dollar units. Large means $1 million, which is the common unit size for negotiable CDs, repos, and commercial paper. Federal agency debt trades in $500,000 unit size. Treasury bills are the exception and trade in $100 units. The Treasury wants all investors to be able to buy its debt.

From July 2007 through December 2009, the amount of financial CP outstanding declined from $781 bil. to $593 bil., which is about a 24% decrease.

Taylor and Williams (2009) note that BNP Paribus’ halting redemptions in these funds is generally recognized as the beginning of the financial crisis. At the time of the BNP Paribus action the amount outstanding in the ABCP market was about $1.2 trillion and by August 2008 (the month before Lehman filed for bankruptcy) the amount outstanding in ABCP had declined by $500 billion (Akay et al. 2013). By the end of the financial crisis in December 2009, the amount of ABCP outstanding had declined to $452 bil., which is about a 62% decrease across the financial crisis.

Since the Lehman bankruptcy is a key event in the financial crisis, we need to mention Lehman’s use of repo 105 and repo 108 transactions. These transactions were used by Lehman to window-dress its balance sheet in the months leading up to it bankruptcy. These transactions relate to the amount of collateral Lehman provided and did not reflect general market conditions. Accordingly, this is unlikely to affect the price of other repos. See, Griffiths et al. (2012) for a discussion of these transactions.

Using the natural log of audit fees is common practice in the audit fee literature. An alternative method to natural logs to control for outliers is to winsorize the data. We estimate all of our regression models with winsorized (at various levels) dollar audit fees as the dependent variable. The winsorized data yields similar results to the natural log of audits fees. We do not report the winsorized results in the interest of brevity.

The variables are defined in “Appendix”.

Recall from footnote #13 that Goldie et al. (2018) identify PWC as an audit specialist in bond mutual funds and that as a bond audit specialist they receive higher audit fees. Their sample period is 2005 through 2009, which includes the financial crisis.

We specifically referred to these recent studies: Ettredge et al. (2014a, b), Goncharov et al. (2014), and Goldie et al. (2018).

Prime funds have 39% of their audits done during the busy season, while Government funds have 34% of their audits done during the busy season.

2008 saw the TARP to bailout banks. Also, the Fed implemented AMLF to support Prime MMFs holding ABCP [see, Akay et al. (2013)] and CPFF to purchase ABCP (Fairbanks et al. 2019). This support could explain that increase in ABCP in bank affiliated MMFs, but exploring this increase is beyond the scope of this paper.

See, Wall Street Journal, 8/20/2018, CPAs fight to Protect part of the Turf.

Akay OO, Griffiths MD, Kotomin V, Winters DB (2013) A look inside AMLF: what traded and who benefited. J Bank Finance 37(5):1643–1657CrossRef

Akay OO, Griffiths MD, Winters DB (2015) Changing rule 2a–7 and the risk profiles of money market mutual funds. J Appl Finance 25(1):15

Anderson R, Gascon C (2009) The commercial paper market, the Fed, and the 2007–2009 financial crisis. Fed Reserve Bank St Louis Rev 91(6):589–612

Asthana SC, Boone JP (2012) Abnormal audit fee and audit quality. Audit J Pract Theory 31(3):1–22CrossRef

Ball R (2009) Market and political/regulatory perspectives on the recent accounting scandals. J Account Res 47(2):277–323CrossRef

Bell TB, Griffin JB (2012) Commentary on auditing high-uncertainty fair value estimates. Audit J Pract Theory 31(1):147–155CrossRef

Blankley AI, Hurtt DN, MacGregor JE (2012) Abnormal audit fees and restatements. Audit J Pract Theory 31(1):79–96CrossRef

Covitz D, Liang N, Suarez GA (2013) The evolution of a financial crisis: collapse of the asset-backed commercial paper market. J Finance 68(3):815–848CrossRef

Cyree KB, Griffiths MD, Winters DB (2016) US bank lending activity in the postcrisis world. J Financ Res 39(4):389–410CrossRef

Desai H, Rajgopal S, Yu JJ (2016) Were information intermediaries sensitive to the financial statement-based leading indicators of bank distress prior to the financial crisis? Contemp Account Res 33(2):576–606CrossRef

Doogar R, Rowe SP, Sivadasan P (2015) Asleep at the wheel (again)? Bank audits during the lead-up to the financial crisis. Contemp Account Res 32(1):358–391CrossRef

Doty J (2011). https://www.banking.senate.gov/public/index.cfm/hearings?ID=0F533E5B-DC43-4FC2-A415-5DF2AE8806DA

Ettredge M, Fuerherm EE, Li C (2014a) Fee pressure and audit quality. Acc Organ Soc 39(4):247–263CrossRef

Ettredge ML, Xu Y, Yi HS (2014b) Fair value measurements and audit fees: evidence from the banking industry. Audit J Pract Theory 33(3):33–58CrossRef

Fairbanks J, Griffiths M, Winters D (2019) Financial crisis solutions in the commercial paper market. Manag Finance 22:3–22

Goelzer D (2010) Speech presented at the 2010 AICPA national conference on current SEC and PCAOB developments, Washington, DC

Goldie BA, Li L, Masli A (2018) Do mutual fund investors care about auditor quality? Contemp Account Res 35(3):1505–1532CrossRef

Goncharov I, Riedl EJ, Sellhorn T (2014) Fair value and audit fees. Rev Acc Stud 19(1):210–241CrossRef

Gorton G, Metrick A (2012) Securitized banking and the run on repo. J Financ Econ 104(3):425–451CrossRef

Griffiths MD, Kotomin V, Winters DB (2012) A crisis of confidence: understanding money markets during the financial crisis. J Appl Finance 22(2):61–82

Ireland JC, Lennox CS (2002) The large audit firm fee premium: a case of selectivity bias? J Account Audit Finance 17(1):73–91CrossRef

Kacperczyk M, Schnabl P (2010) When safe proved risky: commercial paper during the financial crisis of 2007–2009. J Econ Perspect 24(1):29–50CrossRef

Kacperczyk M, Schnabl P (2013) How safe are money market funds? Q J Econ 128(3):1073–1122CrossRef

McCabe PE (2010) The cross section of money market fund risks and financial crises (no. 2010–51). Board of Governors of the Federal Reserve System (US)

Robinson D, Smith T, Valencia A (2018) Does managerial opportunism explain the differential pricing of level 3 fair value estimates? J Financ Research 41(2):253–289CrossRef

Seidman L (2011). https://www.banking.senate.gov/public/index.cfm/hearings?ID=0F533E5B-DC43-4FC2-A415-5DF2AE8806DA

Shroff N (2017) Corporate investment and changes in GAAP. Rev Acc Stud 22(1):1–63CrossRef

Sikka P (2009) Financial crisis and the silence of the auditors. Acc Organ Soc 34(6–7):868–873CrossRef

Sridharan UV, Caines WR, McMillan J, Summers S (2002) Financial statement transparency and auditor responsibility: Enron and Andersen. Int J Audit 6(3):277–286CrossRef

Taylor JB, Williams JC (2009) A black swan in the money market. Am Econ J Macroecon 1(1):58–83CrossRef

Xu Y, Carson E, Fargher N, Jiang L (2013) Responses by Australian auditors to the global financial crisis. Account Finance 53(1):301–338CrossRef

Zhang Y, Monroe GS, Gasbarro D, Cullen G, Shailer G (2011, Aug) Asset securitizations and audit effort. In: 24th Australian finance and banking conference

Title: Auditor response to changing risk: money market funds during the financial crisis
Authors: Kyle D. Allen
Drew B. Winters
Publication date: 07-08-2020
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 3/2021
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-020-00918-5

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 3/2021

Lottery-type stocks and corporate strategies at the turn of the month

Asymmetrical impacts from overnight returns on stock returns

Do failed auditors receive lower audit fees from continuing engagements?

Earnings management surrounding forced CEO turnover: evidence from the U.S. property-casualty insurance industry

A new measure of model misspecification with the no-arbitrage constraint: extending the second Hansen–Jagannathan distance

Revisiting disposition effect and momentum: a quantile regression perspective