Key Audit Matters and the Pricing of Audit Services: Evidence from Hong Kong

Abstract

Auditors identify, assess, and respond to risks of material misstatement in the financial statements of the clients they audit. This study examines whether textual features of key audit matters (KAMs) disclosed in the audit reports of Hong Kong publicly-listed firms are reflected in the pricing of audit services. We find that audit fees are increasing in the length, complexity, and litigious or weak tone of KAM disclosures and decreasing in the similarity of KAMs to industry peers. Separating the textual content of KAM risk descriptions and auditor responses, we find that audit fees load on the complexity, litigiousness and similarity of risk descriptions and the length and weak tone of auditor responses. In addition, we find that indications of control risk concerns in risk descriptions are incrementally informative for audit fees. Results are robust to controlling for the textual features of the footnote disclosures referenced in KAMs. Finally, we show that our results are insignificant for the Chinese state-owned firms in our sample, indicating that KAM disclosures have limited value in the absence of strong demands for high audit quality.

Keywords: Key Audit Matters; Expanded Auditor Reports; Audit Fees; Textual Analysis

JEL Classification: M42