Article2022

The Effects of Critical Audit Matter Disclosure on Audit Effort, Investor Scrutiny, and Investment Efficiency

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

ABSTRACT We study the effects of the disclosure of critical audit matters (CAMs) on an auditor’s audit effort and an investor’s scrutiny effort decisions and on investment efficiency. Both the auditor and the investor can prevent a bad investment by respectively auditing and scrutinizing the firm’s financial reports to detect misstatements about the investment value. Investment efficiency is determined by the investor’s total mix of information. The disclosure of CAMs helps the investor assess investment risk and infer the auditor’s effort and thus enables the investor to fine-tune scrutiny effort, which can in turn adversely influence the auditor’s effort decision. We show when and why the disclosure of CAMs increases or decreases ex ante audit effort, ex ante investor scrutiny, and investment efficiency. Our analyses have both testable empirical implications and policy implications. JEL Classifications: M42; M48.

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References

1985Multimarket Oligopoly: Strategic Substitutes and Complements 1993Auditing Standards, Legal Liability, and Auditor Wealth 2016Risk Disclosure Preceding Negative Outcomes: The Effects of Reporting Critical Audit Matters on Judgments of Auditor Liability 2016The Effects of Critical Audit Matter Paragraphs and Accounting Standard Precision on Auditor Liability 2019The Forewarning Effect of Critical Audit Matter Disclosures Involving Measurement Uncertainty*1999Financial Reporting and Auditing Under Alternative Damage Apportionment Rules 1995Incorporation and the audit market 2009Auditor Liability and Client Acceptance Decisions

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