Do Critical Audit Matter Paragraphs in the Audit Report Change Nonprofessional Investors' Decision to Invest?

Abstract

SUMMARY: Both U.S. and international standard setters have recently proposed changes to the standard audit report, including a requirement to include a critical audit matter (CAM) paragraph. We examine how nonprofessional investors react to an audit report's CAM paragraph that is centered on the audit of fair value estimates. We perform an experiment with nonprofessional investors who are business school graduates who invest in individual stocks and analyze company financial data. We find that investors who receive a CAM paragraph are more likely to change their investment decision than are investors who receive a standard audit report (an information effect) or investors who receive the same CAM paragraph information in management's footnotes (a source credibility effect). We also find that the effect of a CAM paragraph is reduced when it is followed by a paragraph offering resolution of the critical audit matter. Our findings should be of interest to regulators and standard setters as they consider the feasibility of CAM paragraphs and whether and how to convey the resolution of critical audit matters.

The Perceptions and Determinants of Auditing and Reporting Quality in the Asia‐Pacific Region

“…Likewise, the adoption of ISA is also associated with ARQ in line with prior studies such as Boolaky () and Christensen et al. (). The authors suggest that investors are more reliant on the audit report if the latter provides information on key audit matters as required by the revised ISA on audit reporting.…”

“…Lastly, following the approval of a revised standard for a new reporting model by the IAASB in 2014, Christensen et al. () conducted an experimental study to examine how nonprofessional investors react to a key audit matter (KAM) paragraph in the new audit reporting model. The experiment was performed on a number of business school graduates (nonprofessional investors) who invested in stocks and analysed company financial data.…”

“…; Christensen et al. ; Boolaky and Cooper ). However, none of these studies explicitly considers the role of ISA and IFRS adoption and the type of political system on ARQ.…”

Bank Directors’ Perceptions of Expanded Auditor's Reports

“…In addition to this archival study from France, there are some North American experimental studies on the effect of KAM disclosure (or critical audit matters, the term used by the PCAOB). Christensen, Glover and Wolfe () performed an experiment with nonprofessional investors who are business school alumni of a large, public US university who invest in individual stocks and analyse company financial data. They investigated how these subjects react to an audit report's critical audit matter paragraph that is centred on the audit of fair value estimates, and found that investors are indeed more likely to stop considering the firm as an investment.…”

The New European Audit Regulation Arena: Discussion of New Rules and Ideas for Future Research

“…For research concerning KAM, see Christensen, Glover, and Wolfe (), Simnett and Huggins (), Kachelmeier, Schmidt, and Valentine (), Sirois, Bédard, and Bera (), Brasel et al (), Boolaky and Quick () and Gimbar, Hansen, and Ozlanski ().…”