Do Investors Respond to Explanatory Language Included in Unqualified Audit Reports?

Abstract

ABSTRACTThis article investigates whether investors respond to explanatory language (EL) added to unqualified audit reports. Although prior research finds an association between auditor EL and lower financial reporting quality, surveys suggest that many investors limit their attention to the unqualified nature of the opinion. We use three‐day abnormal returns and abnormal trading volume to measure investor response to EL in unqualified audit reports issued from 2000 to 2014. We find little evidence to indicate that investors respond to auditor EL at the audit report release date. In further analyses, we find that the lack of investor response is attributable both to incomplete investor reactions (55 percent of EL occurrences) and previous incorporation of EL (40 percent of EL occurrences). Overall, the results support policymakers’ initiatives to improve the usefulness of unqualified audit reports.