Do Key Audit Matters Impact Financial Reporting Behavior?

Abstract

Our paper examines whether the implementation of KAM in auditors’ reports affects managers’ reporting behavior. In line with prior research in psychology, we argue that greater transparency through KAM sections lead to higher accountability pressure as managers may expect their judgments to be scrutinized more strongly in the presence of KAM and hence, to an improvement of financial reporting quality. Further, we examine whether informational precision (firm-specific versus non-firm-specific information) in KAM sections moderates the effect of KAM presence on reporting behavior. Our results show that participants' tendency to manage earnings decreases with increased information precision. Thus, we find that participants who received an auditor report with a KAM section including firm-specific content are less likely to engage in earnings management activities than participants who received a traditional auditor report. However, we obtain inconclusive results regarding the auditor report including KAM sections with low informational precision. Thus, our results suggest that KAM serve as a beneficial mechanism for enhancing managerial financial reporting quality, but only when information precision in KAM sections is high.

Keywords: Key Audit Matters (KAM), Audit Regulation, Financial Reporting Behavior, Accountability Theory

JEL Classification: C91, M42, D81