The Effect of Audit Report Specificity Regarding Critical Audit Matters on Investors’ Judgments and Decisions

• In Event: 3.01 Critical Audit Matters and Norm Sensitivity

Abstract

The Public Company Accounting Oversight Board (PCAOB) has recently approved a significant expansion to the audit report in the form of critical audit matters (CAMs). The final rule (PCAOB 2017) prescribes a principles-based framework for disclosing CAMs and the related audit procedures, allowing the auditor substantial latitude in what they disclose in the audit report to comply with their new mandate. We investigate the extent to which the specificity of disclosures related to (1) a CAM itself and (2) the audit procedures used to address the CAM impact investors’ assessments of CAM account quality, audit report quality, as well as their investment decisions. Using business school alumni as a proxy for nonprofessional investors, we find that a detailed description of the related audit procedures leads to greater perceptions of both audit quality and CAM account quality than a generic description. Evidence also shows that investors’ investment in the disclosing firm are significantly higher when both CAM disclosure is generic and audit procedure disclosure is detailed. These results have implications for researchers, practitioners, and regulators to carefully consider the language used to disclose CAMs and related audit procedures in the auditor’s report.

Authors

• Peter Kipp, University of North Texas

• Lisa Milici Gaynor, University of South Florida