The Effects of Disclosing Critical Audit Matters and Auditor Tenure on Investors’ Judgments

Posted: 19 Dec 2018 Last revised: 22 Feb 2022

See all articles by Eric T. Rapley

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting

Jesse C. Robertson

University of North Texas

Jason L. Smith

University of Nevada, Las Vegas

Date Written: October 26, 2020

Abstract

In an effort to provide more meaningful information to financial statement users, the Public Company Accounting Oversight Board (PCAOB) recently adopted sweeping changes to the audit report, requiring the audit firm to disclose whether or not it identified a critical audit matter (CAM) and its tenure with the client. To our knowledge, ours is the first study to explore how nonprofessional investors’ judgments are influenced by (1) the relative effects of a CAM disclosure versus a disclosure that the auditor did not identify a CAM, and (2) the disclosure of the audit firm’s tenure. We find that, relative to disclosing that no CAMs were identified, disclosing a CAM reduces investment intentions. We do not find a significant effect of tenure disclosure on investment intentions, despite evidence that participants attended to and understood the tenure manipulation. Concerning investors’ cognitive processes, we find that perceptions of both risk of material misstatement and management disclosure credibility mediate the effect of CAM disclosure on investment intentions, while perceived audit quality suppresses this effect. Our contributions include furthering the understanding of cognitive mechanisms through which CAM disclosure influences investment intentions, identifying a relatively unique setting in which perceptions of management disclosure credibility and audit quality move in opposite directions, and providing evidence that auditor tenure disclosure does not appear to affect investment intentions. Our findings should be of interest to regulators, auditors, issuers, and investors.

Keywords: Critical audit matters; auditor tenure; nonprofessional investors; management disclosure credibility; audit quality.

JEL Classification: M40, M41, M42

Suggested Citation

Rapley, Eric T. and Robertson, Jesse C. and Smith, Jason L., The Effects of Disclosing Critical Audit Matters and Auditor Tenure on Investors’ Judgments (October 26, 2020). Journal of Accounting and Public Policy, Vol. 40, No. 5, 2021, Available at SSRN: https://ssrn.com/abstract=3294340 or http://dx.doi.org/10.2139/ssrn.3294340

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting ( email )

257 Rockwell Hall
Fort Collins, CO 80523
United States
970.491.7481 (Phone)

Jesse C. Robertson (Contact Author)

University of North Texas ( email )

1155 Union Circle #305340
Denton, TX 76203
United States

Jason L. Smith

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

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