Auditor Materiality Disclosures and Investor Trust: How to Address Conditional Risks of Disclosure Mandates

Abstract

ABSTRACT This study contributes to the literature examining the benefits and costs associated with auditor quantitative materiality disclosures. We conduct an experiment to examine a conditional risk associated with such disclosures: that investors with heightened concerns about earnings management, a qualitative concern, will anchor too strongly to the quantitative threshold and lose trust in the audit. The experiment manipulates (1) whether investor concerns about earnings management are low or high and (2) whether auditors provide a quantitative materiality disclosure. We find that quantitative materiality disclosures mislead investors when they have high concerns about earnings management. Specifically, investors lose trust in the auditor’s ability to identify errors that are quantitatively small, but important from a qualitative perspective. A second experiment further suggests that auditors’ provision of detailed, rather than nominal, qualitative materiality disclosures can mitigate this conditional risk. Our study contributes to practice and literature on financial disclosure, materiality, and investor behavior. Data Availability: Data are available from the authors upon request.