Is the Expanded Model of Audit Reporting Informative to Investors? Evidence from the UK

• In Event: International Evidence

Abstract

The U.K. recently introduced changes to the audit reporting model in an effort to improve the information environment for investors. The changes include the requirement that auditors disclose the risks of material misstatement that had the greatest effect on the overall audit strategy, resource allocation, and audit effort. Using long-window equity valuation models, we test whether investors view the new auditor risk disclosures as reliable and incrementally informative. Consistent with the new disclosures reliably capturing the uncertainty in accounting measurements, we find that the valuation coefficients on earnings and net assets are smaller for companies where auditors report a greater number of risks of material misstatement. However, inconsistent with the disclosures being incrementally informative, we find that the valuation coefficients are not significantly different in the year that the new audit reports become publicly available compared with the prior year. Moreover, we find insignificant market reactions to the new disclosures using short-window tests.

Authors

• Clive Lennox, Nanyang Technological University

• Jaime J Schmidt, University of Texas at Austin

• Anne Margaret Thompson, University of Illinois-Urbana-Champaign