Critical Audit Matters: Possible Market Misinterpretation

Abstract

The Public Company Accounting Oversight Board (PCAOB) recently expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. We study the first wave of CAM disclosers from July 2019 to May 2020, which included large accelerated filers reporting on their 2019 fiscal year results. We examine whether market participants erroneously perceive firms with more extensive CAM disclosures to be riskier than firms with less extensive CAM disclosures. We find that firms with more extensive CAM disclosures are associated with increased perceived uncertainty: stock prices of these firms are significantly more volatile and analysts’ forecasts are significantly more dispersed than those of firms with less extensive CAM disclosures.

The determinants of linguistic features in key audit matters: Empirical evidence from Europe

“…closures and investigate the consequences of variation in these features but are largely silent on its determinants (e.g., Burke et al, 2023;Gutierrez et al, 2018;Klevak et al, 2022;Liao et al, 2022;Seebeck & Kaya, 2022;Zeng et al, 2021). 6 The International Standard on Auditing (ISA) 701 "Communicating Key Audit Matters in the Independent Auditor's Report" became effective for audits of financial statements ending on or after 15 December 2016.…”

“…In general, studies find that the number of KAMs increases with client risk and complexity (e.g. Camacho-Miñano et al, 2023;Klevak et al, 2022;Pinto & Morais, 2019;Smith, 2023). In contrast, there is inconsistent evidence for audit firm characteristics such as size, industry expertise and level of client dependence influencing the number of KAMs (e.g.…”

“…Second, this study provides fine‐grained evidence about the textual characteristics of KAMs on a large‐scale sample. Prior studies that quantify KAM disclosures predominantly focus on the number of KAMs (Camacho‐Miñano et al, 2023; Liao et al, 2022), their type (Bepari et al, 2022; Sierra‐García et al, 2019), their length (Burke et al, 2023; Gutierrez et al, 2018; Klevak et al, 2022), their readability (Abdelfattah et al, 2021; Seebeck & Kaya, 2022; Smith, 2023), tonality (Smith, 2023) and boilerplate language (Carlé et al, 2023; Seebeck, 2023). This study provides evidence for additional textual characteristics, such as forward‐looking information and quantitative density therefore providing deeper insight into the KAM reporting behaviour.…”

Does expanded disclosure in the audit report involve unintended consequences? Evidence from tax avoidance

“…This stream of research suggests that KAMs and other similar disclosure requirements convey little incremental information to users. However, Klevak et al (2023) reported that CAMs disclosures are associated with more volatile stock prices and dispersed analyst forecasts, suggesting that users misinterpret the disclosure of more CAMs. Porumb et al (2021) found that RMMs help lenders precisely assess borrowing risks, leading to less stringent loan contracting terms in the post-adoption period.…”

“…These results are consistent with those of previous studies. For example, Klevak et al (2023) reported that investors misinterpret CAMs and react negatively to disclosures. Gutierrez et al (2018), Bedard et al (2019), Lennox et al (2022) and Burke et al (2023) reported that KAMs and similar disclosures have little influence on investors and do not affect audit quality.…”