The Effects of Disclosing Critical Audit Matters and Auditor Tenure on Investors’ Judgments

• In Event: 3.01 Critical Audit Matters and Norm Sensitivity

Abstract

The Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring auditors to disclose: (1) whether the auditor discloses a critical audit matter (CAM) or explicitly state that no CAMs were identified, and (2) the length of the firm’s tenure with the client. To our knowledge, ours is the first experimental study to provide evidence on the effects of these changes on investors’ judgments. We find that disclosing a CAM reduces investment intentions and the perceived quality of management’s role in the financial reporting process, while simultaneously increasing perceived audit quality and the risk that the financial statements contain a material misstatement. Further, both management’s role in influencing financial reporting quality and the risk of misstatement mediate the relationship between CAM disclosure and investment intentions, and CAM disclosure indirectly affects investment intention through perceived audit quality. Finally, we find no effect of tenure disclosure on investment intentions. We offer several contributions, including a better understanding of the cognitive mechanisms through which CAM disclosure influences investment intentions, and that investors do not appear to find tenure disclosure to be informative.

Authors

• Eric T Rapley, Colorado State University

• Jesse C Robertson, University of North Texas

• Jason L. Smith, University of Nevada-Las Vegas