Litigation Risk and Key Audit Matter Disclosures: Evidence From a Quasi‐Natural Experiment in China

ABSTRACT This paper examines how auditors have responded to the impact of the introduction of the new securities law and focuses on the disclosure of KAMs. A generalised DID experiment was conducted by dividing the control group according to the level of firms' accrued surplus management. The results show that after the introduction of the new securities law, KAMs as ‘disclaimers’ are significantly less similar in the same industry, and auditors pay attention to and disclose more company‐specific risks. The perception of risk that the new securities laws create for auditors is a central mechanism for realising this path of action. This effect is even more pronounced for firms that employ industry‐specialist auditors and diversify their operations. At the same time, firms' own level of internal controls and other external regulation to which they are subject also influence the role of the new securities laws on key audit matters. Further research also found that the introduction of the new securities law led to an increase in audit fees and hours and a change in the form of disclosure of KAMs. These results shed light on the role of external regulation through auditors following the introduction of the new securities law and provide some insights into policy governance.