Do Key Audit Matters Affect Operating Activities? Evidence from Inventory Management

Abstract

We investigate whether and how the disclosure of key audit matters (KAMs) affects firms' real operating decisions by examining the association between inventory‐related KAMs and firms' inventory management. Exploiting China's recent audit report reform, our difference‐in‐difference analysis reveals that after the reform, inventory management efficiency increases more for firms subject to inventory‐related KAMs than for other firms and the effect is more pronounced for industries in which inventory is material. Further analyses show that inventory‐related KAMs positively affect inventory management by attracting external attention and increasing auditor monitoring, which in turn improves inventory management efficiency and operating performance. Our findings suggest that KAM disclosure changes firms’ managerial behaviours and generates a positive externality on real operations.