The Disclosure and Consequences of U.S. Critical Audit Matters

Description

This study uses difference-in-differences (DiD) analyses to examine the consequences of adopting the U.S. critical audit matter (CAM) disclosure requirement for preparers and users of financial reports. The CAM requirement is one of the largest expansions of the U.S. audit report since the 1940s. We document significant changes to financial statement footnotes referenced by CAMs, which suggests an indirect consequence where management disclosure changes in areas that are expected to be scrutinized following auditor-provided disclosure. Results also suggest that, on average, CAM disclosures do not provide incremental information to the market. To further examine market reaction, we develop well-specified prediction models for the expected number and subject areas of CAMs. We find limited initial evidence that the market reacts negatively when unexpected CAMs are disclosed. Overall, the findings provide insights on the new CAM standard and particularly demonstrate its relevance to management disclosure decisions and to the market.

Highlights

• Critical audit matters (CAM) • PCAOB • Expanded audit report • XBRL • Footnote disclosure • Textual analysis • Market reaction • Unexpected disclosures • Audit quality • Audit fees

Objectives

• Apply DiD analyses to assess the implications of implementing the U.S. Critical Audit Matter (CAM) disclosure requirement for both preparers and users of financial reports. • Develop and utilize prediction models to anticipate the number and subject areas of CAMs, evaluating market reactions to unexpected disclosures.