Unintended Effects of Critical Audit Matters: Early Evidence

SUMMARY The PCAOB mandated a substantial change to the auditor report in 2017, requiring audit firms to start disclosing critical audit matters (CAMs). Klevak, Livnat, Pei, and Suslava (2023) examine the market reaction to the first wave of CAMs between July 2019 and May 2020 and find that the extensiveness of the CAM disclosures coincides with greater stock return volatility and analyst dispersion. In addition, companies with more extensive CAMs experience lower returns, implying lower valuations by the market. The evidence suggests that capital market participants perceive companies with more extensive CAM disclosures and more audit procedures to have higher business risk and uncertainty, even though CAMs were intended to provide more clarity about the audit. The findings are useful for regulators to measure the impact of regulation and to design future standards. Auditors and managers may also consider the conclusions of this study when communicating information about CAMs.