Why it Matters: The Key Role of the Audit Committee in Expanded Audit Reporting Quality

Abstract

Regulators adopted expanded audit reporting standards in response to investors’ calls for greater transparency about the most important matters the auditor discussed with those charged with governance. However, researchers and regulators know very little about whether and how governance actors influence expanded audit reporting quality. This study investigates how the audit committee’s (AC’s) cognitive diversity, demographic diversity, and power affect key audit matter (KAM) quality. KAM quality refers to the transparency of the KAM report (number, length, readability, and tonal bias), and the tailoring of KAMs to specific engagement-years (textual and topical deviations from prior year KAMs and those of industry-year peers). I find that AC cognitive diversity in expertise, knowledge, and abilities is positively associated with KAM quality and that this relation is stronger in financially distressed firms and firms with weaker information environments. I find limited evidence of associations between demographic diversity and KAM quality, providing evidence that professional rather than personal backgrounds shape the AC’s KAM oversight approach. I find that AC power is negatively associated with KAM quality, consistent with distraction and complacency effects among busier board members with long tenures. This study informs researchers, regulators, and practitioners about ongoing efforts to improve transparency at the intersection of audit assurance and corporate governance.

Keywords: Key audit matters, critical audit matters, expanded audit report, audit committee, corporate governance, textual analysis, auditor disclosure