Mandatorily Disclosed Materiality Thresholds, their Determinants, and their Association with Earnings Multiples

Is More Always Better? Disclosures in the Expanded Audit Report and Their Impact on Loan Contracting

“…Our study adds to the emerging literature on the effects of adjusting the informational content of the audit report (Amiram et al 2017;Lennox et al 2018;Reid et al 2016;Gutierrez et al 2018;Smith 2017), and is, to the best of our knowledge, the first study to empirically assess its usefulness from a debt market perspective. Our study contributes to both the loan contracting and the auditing literature by documenting that the expanded audit report disclosures (1) shape loan contracting by reducing borrowers' information asymmetry, and 2represent a direct channel through which banks gather information regarding borrowers' risk of financial misreporting.…”

“…The empirical results provide evidence that lenders use RMM information when determining loan contracting terms and, more importantly, that they distinguish between different types of RMMs when deciding on these terms. Consequently, our study contributes to the literature on the usefulness of mandatory audit disclosure (Leftwich 1983;Dye 1990;Admati and Pfleiderer 2000;Lennox and Pittman 2011) and complements the emerging stream of literature that assesses the equity market effects of adjusting the informational content of the audit report (Amiram et al 2017;Smith 2017;Gutierrez et al 2018;Lennox et al 2018;Reid et al 2018). We are, to the best of our knowledge, the first to empirically assess the usefulness of the expanded audit report for private debt holders.…”

“…Although still inconclusive (Lennox et al 2018;Reid et al 2018), contemporaneous empirical evidence from research analyzing the UK setting indicates reduced information asymmetry following the disclosure of expanded audit reports(e.g., Amiram et al 2017;Reid et al 2018). This evidence is consistent with the theoretical prediction that high-quality disclosure reduces information asymmetry (e.g., Diamond and Verrecchia 1991;Brown and Hillegeist 2007;Bhattacharya, Desai, and Venkataraman 2013).…”

Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability

“…As discussed in Section 2.1, our descriptive analysis addresses a lack of basic knowledge of materiality judgments and sheds light on questions raised by, for example, Chewning and Higgs (2002) about such matters as the consistency of materiality judgments, including across industries, over time and across audit firms. 5 Our analysis of actual materiality judgments extends previous archival research that uses indirect approaches or analyzes non-US data (e.g., Acito et al 2009;Eilifsen and Messier 2015;Amiram et al 2017;Gutierrez et al 2016;Acito et al 2018). Our evidence indicates auditors do not set materiality thresholds by applying a simple rule-of-thumb; rather, materiality amounts vary in ways that suggest auditors are both applying judgment within their audit firms' 5 As discussed in Section 2.1, previous empirical-archival researchers have not been able to link an engagementspecific materiality amount to that client's financial reporting characteristics.…”

“…(1) used a different percentage; (2) used adjusted pretax income, for example, to exclude non- 11 Amiram et al (2017) report monetary values of materiality thresholds divided by total assets for 142 large nonfinancial clients in the UK and Gutierrez et al (2016) report data on materiality expressed as a percent of assets, as well as audit costs and other factors for varying numbers of UK non-financial clients. In untabulated analyses, we find that after controlling for client size, audit firm and year, UK auditors are less likely than our US-sample auditors to use assets or revenue as the materiality base and report higher monetary materiality amounts on average (p<0.01).…”