The Effect of Increased Audit Disclosure on Managers’ Real Operating Decisions: Evidence from Disclosing Critical Audit Matters

We investigate whether and how a “critical audit matter” (CAM) disclosure affects managers’ real operating decisions in two contexts (issuing a loan that decreases versus increases the average risk profile of loan portfolios, or choosing to hedge versus speculate on commodity risk). We expect a CAM disclosure increases disclosure costs and implies expanded auditor support for both types of activities; but we expect implied auditor support to be valued more highly for risk-increasing than for risk-decreasing activities. As a result, we predict that a CAM disclosure decreases managers’ risk-decreasing activities (due to increased disclosure costs) more than managers’ risk-increasing activities (as the implied auditor support counteracts the increased disclosure costs). We find evidence consistent with our prediction across multiple experiments. Our study sheds light on unintended consequences of a CAM disclosure and provides insight to relevant parties as the new standard goes into effect.