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

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  • Keith Czerney
  • Jaime J. Schmidt
  • Anne M. Thompson

Abstract

This 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. Les investisseurs réagissent‐ils au texte explicatif des rapports d'audit sans réserve ? Les auteurs se demandent si les investisseurs réagissent au texte explicatif ajouté dans les rapports d'audit sans réserve. Bien qu'un lien entre le texte explicatif de l'auditeur et la qualité inférieure de l'information financière ait été observé dans de précédentes études, les sondages semblent indiquer que seule l'absence de réserve dans le rapport d'audit retient l'attention de bon nombre d'investisseurs. Les auteurs utilisent les rendements anormaux et les volumes d’échange anormaux notés sur une période de trois jours pour évaluer la réaction des investisseurs au texte explicatif que contiennent les rapports d'audit sans réserve publiés entre 2000 et 2014. Ils relèvent peu d'indications susceptibles de confirmer que les investisseurs réagissent au texte explicatif de l'auditeur à la date de publication du rapport d'audit. En poussant plus loin leurs analyses, les auteurs constatent que l'absence de réaction des investisseurs est attribuable à la fois à l'incomplétude de leur réaction (55 pour cent des occurrences de texte explicatif) et à l'intégration antérieure du texte explicatif (40 pour cent des occurrences de texte explicatif). Dans l'ensemble, les résultats justifient les efforts des normalisateurs pour améliorer l'utilité des rapports d'audit sans réserve.

Suggested Citation

  • Keith Czerney & Jaime J. Schmidt & Anne M. Thompson, 2019. "Do Investors Respond to Explanatory Language Included in Unqualified Audit Reports?," Contemporary Accounting Research, John Wiley & Sons, vol. 36(1), pages 198-229, March.
    • Handle: RePEc:wly:coacre:v:36:y:2019:i:1:p:198-229
    DOI: 10.1111/1911-3846.12425
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    References listed on IDEAS

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    1. Beaver, Wh, 1968. "Information Content Of Annual Earnings Announcements," Journal of Accounting Research, Wiley Blackwell, vol. 6, pages 67-92.
    2. Orie E. Barron & Richard A. Schneible & Douglas E. Stevens, 2018. "The Changing Behavior of Trading Volume Reactions to Earnings Announcements: Evidence of the Increasing Use of Accounting Earnings News by Investors," Contemporary Accounting Research, John Wiley & Sons, vol. 35(4), pages 1651-1674, December.
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    1. Kang, Yoon Ju, 2019. "Are Audit Committees more challenging given a specific investor base? Does the answer change in the presence of prospective critical audit matter disclosures?," Accounting, Organizations and Society, Elsevier, vol. 77(C), pages 1-1.
    2. Salman Arif & John D. Kepler & Joseph Schroeder & Daniel Taylor, 2022. "Audit process, private information, and insider trading," Review of Accounting Studies, Springer, vol. 27(3), pages 1125-1156, September.
    3. Sandro Brunelli & Chiara Carlino & Rosella Castellano & Alessandro Giosi, 2021. "Going concern modifications and related disclosures in the Italian stock market: do regulatory improvements help investors in capturing financial distress?," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 25(2), pages 433-473, June.
    4. Hyun Ah Kim & Nam Chul Jung, 2020. "The Effect of Corporate Social Performance on Audit Hours: Moderating Role of the Emphasis of Matter Paragraphs in Audit Report," Sustainability, MDPI, vol. 12(3), pages 1-17, January.
    5. Marcus M. Doxey & James G. Lawson & Thomas J. Lopez & Quinn T. Swanquist, 2021. "Do Investors Care Who Did the Audit? Evidence from Form AP," Journal of Accounting Research, Wiley Blackwell, vol. 59(5), pages 1741-1782, December.

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