The Effect of Key Audit Matters Disclosures on Conditional Conservatism in China

ABSTRACT This study investigates the effect of key audit matter (KAM) disclosure on conditional conservatism. Exploiting the exogenous shock of audit regime reform in China and employing a difference‐in‐differences research design, we document a significant increase in the degree of conditional conservatism among Chinese listed firms following the adoption of KAM disclosures. Further textual analysis shows that the informational characteristics of KAMs play a crucial role in shaping management's financial reporting behaviour. Specifically, the disclosure of managerial discretion information in KAMs is positively associated with conditional conservatism, suggesting that increased transparency of managerial assertions induces firms to adopt more prudent accounting practices. In contrast, implied auditor support is negatively related to conditional conservatism, reducing the likelihood of conservative financial reporting by managers. By differentiating the informational effects of KAM content, this study contributes to the literature on audit disclosures and financial reporting conservatism, highlighting the nuanced role of KAMs in influencing managerial reporting incentives.