Regulation risk and the quality of key audit matters: an analysis based on the auditor’s disclosing motivation

ABSTRACT

This research investigates the effect of regulatory risk on the quality of key audit matters (KAMs) through the lens of the auditors’ motivations. Employing STATA to conduct regression analysis on data encompassing 22,075 firm-year observations from Chinese A-share listed companies over the period from 2017 to 2022, we find that auditors with higher regulation risk disclose more KAMs, especially the differentiated KAMs, and provide more details through longer text content. This behaviour is driven by the desire to signal client risks and mitigate audit liability. Additional analysis indicates that the heightened regulatory risk makes auditors more sensitive to the risks related to non-accounting areas, which are less auditable. Meanwhile, audit clients may hinder auditors from disclosing more information in KAMs to avoid additional costs. Finally we also reveal that the regulatory risk enhances the quality of KAMs disclosed by non-Big 4 auditors. Our study sheds light on the motivations behind auditors’ disclosure motivations while informing regulators and investors to pay closer attention to the quality of KAMs.

KEYWORDS:

• Regulatory risk
• key audit matter
• disclosing motivation
• audit liability

JEL CLASSIFICATION:

• M41
• M42
• M48

Disclosure statement

No potential conflict of interest was reported by the author(s).