Are Critical Audit Matters Informative?

Abstract

Breaking from a long stretch of using largely standard language in unqualified audit opinions, the Public Company Accounting Oversight Board (PCAOB) expanded audit reports to disclose Critical Audit Matters (CAMs) and the audit procedures used to address them. The first wave of CAM disclosures began for large accelerated filers after June 2019, with most disclosures occurring in February 2020. Using Natural Language Processing (NLP) techniques, this study examines the types of CAMs disclosed by auditors and the typical audit procedures used to address them. We then explore whether CAMs are informative to investors and security analysts. Our findings are consistent with greater amounts of CAM disclosures as indicators of greater uncertainty. We document that market reactions are more negative for firms with more CAM disclosures; analysts reduce their earnings forecasts to a larger extent for such firms; stock prices become more volatile; and the dispersion of analyst forecasts are greater for firms with more CAM disclosures. We further find that many issues related to CAMs are raised in earnings conference calls with analysts during the immediately subsequent quarter. While these findings indicate that CAMs are informative to investors and analysts, their effects are concentrated around the time of disclosure. We do not find evidence of a drift in returns after the initial disclosures.