The Effect of Materiality Disclosures on Investors’ Decision Making
56 Pages Posted: 6 Jan 2018
Date Written: January 4, 2018
Despite regulation requiring the disclosure of audit materiality, recent reviews of the academic literature indicate that little is known regarding how users respond to materiality disclosures or evaluate the level of materiality used by auditors, and what is deemed to be material to various groups of financial statement users (e.g., creditors, shareholders). In response, we examine the effect of audit materiality disclosures on professional investors’ decision making. Additionally, because the need for, and the use of, audited financial statements differs across stakeholder groups, we also examine users’ demand for materiality given certain investment-specific characteristics (debt vs. equity, public vs. private). Among a sample of 246 informed users of financial statements from the U.S. and U.K., we find investors struggle to understand materiality disclosures. Specifically, they fail to make consistent connections between disclosed audit materiality and the level of auditor effort. Further, these judgments are the same across hypothetical debt and equity investments for both public and private companies. In sum, our findings suggest that disclosures of audit materiality are not well understood by investors. This research will inform practitioners, regulators, and academics regarding the effect of materiality disclosure on investor decision making as well as stakeholders’ views and expectations of overall materiality.
Keywords: audit report, investment decisions, investors, materiality disclosure
JEL Classification: M40, M42
Suggested Citation: Suggested Citation