Key audit matters and debt contracting: evidence from China

Abstract

Purpose In an effort to make audit reports more informative to users, the Public Company Accounting Oversight Board and the International Auditing and Assurance Standards Board adopted a standard that requires auditors to disclose key audit matters (KAMs). This paper aims to explore the impact of the risk information provided by KAMs on corporate debt contracting. Design/methodology/approach In China, the KAM standard went into effect for A + H cross-listing companies in 2017 and became mandatory for all listed companies in 2018. This study takes this as an exogenous shock to examine the impact of the KAM disclosures on debt contracting. This study also designs a path analysis to open the “black box” between the risk information in KAMs and the risk perception of creditors. Moreover, This study conducts a textual analysis on the KAMs information based on samples after the release of the KAM standard. Findings This study conducts difference-in-difference tests and find that the KAM disclosures decrease interest rates and increase the proportion of long-term debt. Path analyses reveal that the KAM disclosures lead to more favorable debt characteristics through decreasing information asymmetry. This study also finds that the more KAMs are disclosed, the more favorable debt characteristics are and that different categories of KAMs have different effects on debt contracting. Originality/value This paper highlights the benefits of KAM disclosures, which are consistent with the convergence argument of risk information disclosures. Investors’ reactions to KAMs are mixed because of the differences in how professional investors and nonprofessional investors interpret information. This study provides evidence of incrementally informative nature of KAMs from the perspective of debt holders, who are professional information users.

Mapping the state of expanded audit reporting: a bibliometric view

“…Audit expectation gap; creditors’ benefits and perceptions; investors’ reactions and perceptions; and financial analysts’ forecasts and perceptions are variables that form the third group of EAR consequences, i.e. auditee-stakeholder relationship (Hatherly et al , 1991; Innes et al , 1997; Liu et al , 2022; Rapley et al , 2021; Gutierrez et al , 2018; Venturini et al , 2022; Hu et al , 2022). Following the agency, stakeholders and legitimacy theories, some results of these studies imply that improving the audit report transparency through EAR can reduce the expectations gap, information asymmetry and possible conflicts of interest between management and shareholders and increase the stakeholders’ trust and the company’s legitimacy (Suttipun, 2022; Fuller, 2015).…”

Consideration of Significant Audit Matters: An Evaluation

“…This study argued that the transparency of audit reports might widen the audit expectation gap if the information available is not in the correct context (Segal, 2019;Liu, Ning, Zhang, & Zhang, 2022). The study found that the displayed accounting estimates as part of the KAM do not enhance the decision-usefulness of accounting information (Lau, 2021).…”

Disclaimer effect of key audit matters in China: negative press coverage and boilerplate

“…Conversely, Zeng et al (2021) found that China's KAMs are not overwhelmed by boilerplate text. Liu et al (2022) find that KAMs disclosures in China decrease the interest rate and increase the proportion of long-term debt by improving the information environment.…”