Auditing the Derivative Usage of Bank-Holding Companies

Abstract

Auditing financial derivatives is complex and contentious. Our study examines the impact of derivative use on the risk premium charged by auditors of bank holding companies (BHCs). We find that audit fees are higher regardless of whether derivative instruments are used for hedging and trading. This implies that auditors charge BHCs that use derivatives a risk premium to compensate for additional risk related to these instruments. We also find that trading derivatives tend to have a higher risk premium than hedging derivatives. Our results suggest that auditors price risks related to derivatives and trading derivatives are perceived to be higher risk relative to hedging derivatives.