Auditor Communication of Material Imprecision and Non-Professional Investors’ Judgments

• In Event: Continental Breakfast - Research and Education Forum
  In Roundtable Session: Table 10: Audit Quality Indicators

Abstract

Financial accounting standards increasingly require fair value measurements featuring uncertainty that must be appropriately priced by investors. Regulators’ currently require additional disclosure to convey uncertainty information to financial statement users. However, prior research in accounting indicates that financial statement users do not treat recognized and disclosed information identically, and tend to place more weight on recognized amounts. This study examines whether auditors’ explicit labeling of reported amounts, a technique already applied in practice (e.g., comfort letters for underwriters), changes how financial statement users incorporate information related to this uncertainty in valuation and investing decisions. In a 2 × 2 × 2 experiment, we manipulate management disclosure, auditor disclosure (fully narrative critical auditing matter (“CAM”) communication), and auditor labeling (CAM communication with visual identification of related amounts) and solicit P/E multiple assessments from nonprofessional investor participants. We predict and find that auditor labeling changes nonprofessional investors valuation decisions, suggesting financial statement users find information about the audit to be value relevant. We also find that auditor labeling changes how nonprofessional investors utilize management disclosures about high-uncertainty estimates. The results of our experiment should interest regulators (i.e. PCAOB) as they consider potential changes to auditor’s reporting responsibilities.

Authors

• Jeremy Griffin, University of Notre Dame

• Sean Dennis, University of Wisconsin–Madison

• Karla Johnstone, University of Wisconsin–Madison