Corporate governance and investor's reactions : perspective through key audit matters (KAMs)

Abstract

The issuance of ISA 701: Communicating Key Audit Matters (KAMs) in the Independent Auditor’s Report by IAASB is a significant step toward increasing the value of an auditor's report. This study examines three empirical issues relating to KAM disclosure. First, it investigates whether KAM disclosure affects investors' reactions. Second, this study identifies the impact of corporate governance on KAM disclosure. Third, it discusses whether KAM disclosure can act as a mediator between corporate governance and investors' reactions. The sample for this study consists of 931 firm-year observations on companies listed on the Bursa Malaysia between 2016 and 2019. KAMs are evaluated using KAMSCORE, which considers two dimensions: the quantity and nature of the issues disclosed. Corporate governance is quantified through a score and individual characteristics of the board of directors and audit committees. While investors’ reaction is measured based on share price. The results of panel data analysis showed that KAMSCORE associated positively towards the share price, indicating that KAM disclosure is useful, value relevant, and elicits investors' reactions. Certain individual board and audit committee characteristics have an impact on KAM disclosure. The findings confirmed that sound corporate governance can influence the message delivered by auditors through KAMs. Additionally, this study demonstrated that there are complementary and indirect-only mediation effects between board size, board independence, board expertise, audit committee independence, and female audit committee members with KAM disclosure and the share price. Overall, the empirical results seem to support the agency, signalling, and efficient market hypothesis (EMH), since effective corporate governance affects KAM disclosure and KAM disclosure affects share price. The findings of this study provide feedback to policymakers on the value relevance of KAM disclosure. Due to the value-relevant nature of KAM disclosure, the implementation of KAMs should be extended to unlisted companies and even government agencies. The key limitations are that these findings are solely applicable in the Malaysian environment. Furthermore, corporate governance is measured only via the lens of internal governance mechanisms based on the characteristics of the board and audit committee.