A New Uncertainty Measure—Cam

Abstract

In contrast to past auditor opinions, which were largely unqualified and uniformly written, a new disclosure requirement expands auditors’ opinions to include a description of Critical Audit Matters (“CAMs”) and the audit steps necessary to form an opinion about them. The expanded disclosure provides substantially more information about the areas of financial reporting that auditors consider most uncertain. Using a comprehensive sample of initial CAM disclosures in the 10-K filings for the period of August 2019–May 2020, we find that a larger number of CAMs, a greater number of required auditing procedures, and more wordy and extensive CAM discussions are negatively associated with stock returns immediately following the 10-K filings. We also document significantly more negative analyst earnings revisions for firms whose auditors report more CAMs and provide more verbose CAM disclosures.

TOPICS: Legal/regulatory/public policy, information providers/credit ratings, financial crises and financial market history

Key Findings

• ▪ Under the new PCAOB regulation, auditors include a description of Critical Audit Matters in the audit opinion.

• ▪ More extensive Critical Audit Matters disclosures indicate greater uncertainty inherent in firms’ financial statements.

• ▪ Firms with more extensive Critical Audit Matters disclosures have lower stock returns and lower analyst forecasts.