The Complementary Roles of Audited Financial Reporting and Voluntary Disclosure: A Test of the Confirmation Hypothesis

Abstract

We examine the complementarity between voluntary disclosure and reporting audited financial statement outcomes. We test the “confirmation” hypothesis, that reporting audited, backward-looking outcomes disciplines and hence enhances the precision and credibility of managers’ disclosure of private forward-looking information. Using management earnings forecasts as the voluntary disclosure variable, we report that committing to higher audit fees (a measure of the extent of financial statement verification and thus the accuracy and freedom from manipulation of reported outcomes), is associated with more frequent and more specific management forecasts, and with a larger market reaction to forecasts. These relations are not driven by litigation risk and are robust to a variety of controls. Disclosure of private information and audited financial reporting play complementary roles, which implies they cannot be evaluated separately.

Keywords: Voluntary disclosures, earnings announcements, confirmation hypothesis

JEL Classification: M43, M49