Theoretical and Empirical Analyses of the Antecedents and Outcomes of Key Audit Matters Reporting: Some European Evidence

Anojan Vickneswaran

doi:10.25907/01094

Drawing on some important theories, including agency theory, information asymmetry theory, signalling theory, audit quality theory (literature), institutional theory, knowledge spillover theory (literature), and prior studies, this thesis comprises three empirical essays. The first two essays focus on the outcomes of KAMs reporting, and the final essay focuses on the antecedents of KAMs reporting. Also, the moderating roles of audit firm quality (proxied by Big 4 auditors) and investor legal protection (proxied by common-law tradition) in these relationships are investigated. KAMs reporting is the latest mandatory audit reporting in many jurisdictions since the end of 2016, designed to enhance the communicative value of the audit report. The three essays focused on archival data of listed non-financial firms (5,919 firm-year observations) in a common-law country (the United Kingdom) and civil-law countries (France, Germany, and Italy) from 2018 to 2023 (during the mandatory period of KAMs). Using Preferred Reporting Items for a Systematic Review of Meta-Analysis (PRISMA) guidelines, the Scopus database and some criteria, a systematic literature review synthesises 142 prior studies on antecedents and outcomes of KAMs reporting. It highlights several outcomes of KAMs reporting, including financial reporting quality, audit quality, and mixed evidence regarding audit fees, audit delay and restatements. Prior studies on the antecedents of KAMs show that auditor- and client-related factors, as well as corporate governance characteristics, determine KAMs. Essay one focuses on the association between KAMs and Going Concern Opinions (GCOs), the moderating roles of Big 4 auditors and audit fees in this relationship, and whether these moderating roles differ between common-law and civil-law legal environments. This study finds a significant positive relationship between the number of KAMs and GCOs. This relationship is stronger for Big 4 clients and clients with higher audit fees. Importantly, the moderating role of Big 4 auditors and audit fees in this relationship is limited to UK firms (a common law nation). Additional analyses show a significant positive relationship between the number of KAMs and GCOs across sampled countries. It is more pronounced in Germany, followed by the UK, France, and Italy. These results suggest that KAMs reporting enhances the effectiveness of GCOs (potentially reduces Type II errors), thereby improving auditors’ competence regarding GCOs decisions consistently not only in the stronger investor protection legal environment (common-law countries), but also in the weaker investor protection legal environment (civil-law countries), highlighting the overall quality and success of KAM reporting (requirement). Finally, path analysis results show that the number of KAMs positively mediates the relationship between financial distress level and GCOs. Essay two investigates consequences of KAMs reporting, in terms of Audit Report Lag (ARL), Financial Restatements (FR), and Auditor Dismissals (AD), and the moderating roles of Big 4 auditors and the legal environment on these relationships. The results document a significant positive relationship between the number of KAMs and ARL. This relationship is weaker for Big 4 clients and stronger for UK firms (common law). However, the positive association between the number of KAMs and ARL is attenuated for firms audited by Big 4 auditors in the UK. Additional analysis shows that the relationship between KAMs and ARL, and the moderating role of the Big 4 on this relationship, are observed only among UK firms, not in sampled civil-law nations. The results for FR show a significant positive relationship between the number of KAMs and FR, which is weaker for UK firms. However, it shows no significant moderating effect of Big 4 auditors on the relationship between the number of KAMs and FR. The path analysis shows that ARL significantly mediates the relationship between KAMs and FR. Finally, the results for AD document a significant weak positive relationship between the number of KAMs and AD, which is stronger for Big 4 clients. However, results show no significant moderating role of the legal environment in the association between the number of KAMs and AD. The path analysis results indicate that FR and ARL significantly mediate the relationship between KAMs and AD. The third essay examines the relationship between Non-Audit Fees (NAFs) and KAMs and the moderating role of Big 4 auditors, both collectively and individually. It also investigates whether the relationship between NAFs and KAMs, and the moderating role of Big 4 auditors, differ between common-law and civil-law legal traditions. This study finds a significant positive association between NAFs and both the number of disclosed KAMs (actual number reported in the audit report) and the propensity to report a higher number of KAMs (a binary measure). The results show no overall moderating effect of Big 4 on the relationship between NAFs and the number of KAMs; however, the significant positive relationship between NAFs and a higher number of KAMs is stronger for Big 4 clients. The results on the moderating effect of the individual Big 4 indicate that the significant positive relationship between NAFs and both the number of KAMs and higher KAMs is stronger for Deloitte clients. Furthermore, the relationship between NAFs and a higher number of KAMs is stronger for PWC clients. However, the positive association between NAFs and the number of KAMs is marginally weaker for KPMG clients. EY and PwC show no significant moderation on the relationship between NAFs and the number of KAMs, and EY and KPMG show no significant moderation on the relationship between NAFs and a higher number of KAMs. Finally, the study documents that the relationships between NAFs and the number of KAMs, NAFs and a higher number of KAMs, and the significant moderating role of Big 4 auditors in these relationships are observed only among UK firms. The results are robust across alternative models, variables, and sample specifications. Overall, the three empirical essay results are consistent with the broader literature. The findings have timely implications for several stakeholders, including investors, regulators, standard-setters, firms (top management), auditors, and academics, who pay greater attention to the determinants and outcomes of KAMs, audit quality, legal environment, and auditing harmonisation.

Theoretical and Empirical Analyses of the Antecedents and Outcomes of Key Audit Matters Reporting: Some European Evidence

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