Financial statements are among the most important information source for investors. As “gatekeepers” of the capital market, auditors attest to whether a firm’s financial statements are free from material misstatements and faithfully represent the firm’s financial performance and position.
In recent years, regulators have required auditors to disclose critical audit matters (CAMs) beyond the binary pass/fail opinion. Proponents argue that CAM disclosure will add to investors’ total mix of information—providing insights relevant to analyzing risks in capital valuation and allocation—and will focus investors’ attention on key financial reporting areas that deserve more attention, thus contributing to investors’ ability to make investment decisions. However, to the extent that CAM disclosure improves investment decisions, the associated decrease in investment loss might disincentivize audit effort by decreasing auditors’ expected legal liability. Therefore, whether CAM disclosure can increase investors’ total mix of information is unclear and requires comprehensive economic analysis.
Assistant Professor Nanqin Liu from the Department of Finance at the Southern University of Science and Technology (SUSTech) has published a paper that studies the effects of the disclosure of CAMs on an auditor’s audit effort and an investor’s scrutiny effort decisions, as well as on investment efficiency.
The paper, entitled “The Effects of Critical Audit Matter Disclosure on Audit Effort, Investor Scrutiny, and Investment Efficiency,” was published in The Accounting Review, a top three academic journal in the accounting discipline, and recognized by business schools worldwide.
Prof. Liu’s paper presents a theoretical model to study how CAM disclosure would influence the strategic interactions between the auditor and the investor. Her paper shows that the auditor’s legal liability and the quality of the auditor’s CAM signal are important determinants of the economic consequences of CAM disclosure. CAM disclosure is likely to achieve the regulator’s goal of providing more accurate audit reports and improving investment efficiency, mainly when the auditor’s legal liability is large, and the quality of the auditor’s CAM signal is low.
Asst. Prof. Nanqin Liu and Assoc. Prof. Derek Chan from the University of Hong Kong (HKU) are the only two authors of this paper. Prof. Liu is the corresponding author.
Prof. Nanqin Liu also published another paper in The Accounting Review in 2021. Her research interests mainly include auditing, corporate disclosure, and the interface between finance and operations management.
Paper link: https://doi.org/10.2308/TAR-2020-0121
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Proofread ByAdrian Cremin, Yingying XIA