Are Critical Audit Matters Informative?

48 Pages Posted: 10 Sep 2020

See all articles by Julia Klevak

Julia Klevak

Prudential Financial - Quantitative Management Associates

Joshua Livnat

New York University; Prudential Financial - Quantitative Management Associates

Duo Selina Pei

University of Warwick - Warwick Business School

Kate Suslava

Bucknell University Freeman College of Management

Date Written: September 2, 2020

Abstract

Breaking from a long stretch of using largely standard language in unqualified audit opinions, the Public Company Accounting Oversight Board (PCAOB) expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. The first wave of CAM disclosures began for large accelerated filers after June 2019, with most disclosures occurring in February 2020. Using Natural Language Processing (NLP) techniques, this study examines the types of CAMs disclosed by auditors and the typical audit procedures used to address them. We then explore whether CAMs are informative to investors and security analysts. Our findings are consistent with greater amounts of CAM disclosures as indicators of greater uncertainty. We document that market reactions are more negative for firms with more CAM disclosures; analysts reduce their earnings forecasts to a larger extent for such firms; stock prices become more volatile; and the dispersion of analyst forecasts are greater for firms with more CAM disclosures. We further find that many issues related to CAMs are raised in earnings conference calls with analysts during the immediately subsequent quarter. While these findings indicate that CAMs are informative to investors and analysts, their effects are concentrated around the time of disclosure. We do not find evidence of a drift in returns after the initial disclosures.

Keywords: auditor reports, textual analysis, critical audit matters, abnormal returns

JEL Classification: G12, G14, M41

Suggested Citation

Klevak, Julia and Livnat, Joshua and Pei, Duo and Suslava, Kate, Are Critical Audit Matters Informative? (September 2, 2020). NYU Stern School of Business Forthcoming, Available at SSRN: https://ssrn.com/abstract=3685369 or http://dx.doi.org/10.2139/ssrn.3685369

Julia Klevak

Prudential Financial - Quantitative Management Associates ( email )

2 Gateway Center
6th Fl.
Newark, NJ 07102
United States

Joshua Livnat

New York University ( email )

44 West 4th Street, Suite 10-76
Stern School of Business
New York, NY 10012-1118
United States
212-998-0022 (Phone)
212-995-4004 (Fax)

Prudential Financial - Quantitative Management Associates ( email )

2 Gateway Center
6th Fl.
Newark, NJ 07102
United States

Duo Pei

University of Warwick - Warwick Business School ( email )

Coventry CV4 7AL
United Kingdom

Kate Suslava (Contact Author)

Bucknell University Freeman College of Management ( email )

701 Moore Ave
Lewisburg, PA 18837
United States

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