Have Critical Audit Matter Disclosures Indirectly Benefitted Investors by Constraining Earnings Management? Evidence from Tax Accounts

Abstract

Does the initial disclosure of tax-related critical audit matters (CAMs) constrain tax-related earnings management? If so, it would support the PCOAB’s expectation that investors indirectly benefit from CAMs through the increased attention given to the matters underlying the CAMs. We examine auditors’ initial CAM disclosures of large U.S. accelerated filers and find that tax-related CAM disclosures are associated with a lower likelihood that the audited company uses tax expense to meet analysts’ after-tax consensus forecasts. We find that tax-related CAM disclosures are associated with subsequent increases in the length of and use of uncertain language in tax footnotes. However, we do not find tax-related CAMs are associated with increased audit fees or tax-related non-audit service fees. Our results indicate that the disciplinary benefit of CAMs appears primarily driven by management’s response to CAM disclosures.