Do Investors Respond to Explanatory Language Included in Unqualified Audit Reports?
54 Pages Posted: 7 Jun 2014 Last revised: 2 Nov 2017
Date Written: October 1, 2017
This paper investigates whether investors respond to explanatory language added to unqualified audit reports. Although prior research finds an association between auditor explanatory language and lower financial reporting quality, surveys suggest that many investors limit their attention to the unqualified nature of the opinion. We use three-day abnormal returns and abnormal trading volume to measure investor response to explanatory language in unqualified audit reports issued from 2000-2014. We find little evidence to indicate that investors respond to auditor explanatory language at the audit report release date. In further analyses, we find that the lack of investor response is attributable both to incomplete investor reactions (55 percent of explanatory language occurrences) and previous incorporation of explanatory language (40 percent of explanatory language occurrences). Overall, the results support policymakers’ initiatives to improve the usefulness of unqualified audit reports.
Keywords: explanatory language, audit reports, investor reaction
JEL Classification: M40, M41, M42, M48
Suggested Citation: Suggested Citation