The Consequences of Mandatory Audits for Narrative Disclosures

• In Event: 1.03. Voluntary Disclosure

Abstract

We analyze the effects of mandatory audits of narrative disclosures in financial reports. Exploiting the introduction of a mandatory audit requirement in more than 20 countries in 2015 and 2016, we find a substantial increase in the quantity and quality of narrative disclosures. Specifically, using difference-in-differences analysis with a tight fixed effects structure, we show that narrative disclosures become longer, contain more forward-looking information, and show less boilerplate language. We also find novel evidence that client firms subject to the new audit requirement report less aggressive income-increasing accruals, show a timelier recognition of losses, and an overall improvement in the information environment of financial analysts. These findings are consistent with the notion that auditing narrative disclosures may have positive spillovers to the audit of the financial statements. Moreover, we do not find increases in audit fees, suggesting that synergies help auditors keep the additional workload low. Collectively, our study is the first to document the effects of mandatory audits of narrative disclosures in financial reports.

Authors

• Peter Kajueter, University of Muenster

• Arne Lessenich, University of Münster

• Martin Nienhaus, Goethe University

• Christopher Oehler, Goethe-University Frankfurt