Original Article

Journal of Accounting,
Auditing & Finance
Is Client-Specific Information 1–21
ÓThe Author(s) 2022
Useful to Investors? Evidence Article reuse guidelines:
sagepub.com/journals-permissions
From Key Audit Matter DOI: 10.1177/0148558X221091804
journals.sagepub.com/home/JAF

Reports

Yu-Tzu Chang1 , Wuchun Chi1, and Dan N. Stone2

Abstract
The goal of the mandatory disclosure of Key Audit Matters (KAMs) in the extended audit
report is to provide relevant, client-specific information and thereby add value to the audit
report. But mixed results fuel debate about the informativeness of expanded audit reports,
particularly the disclosure of KAMs. This study employs text analysis to examine whether
and how the information content of KAMs is associated with investor perceptions of finan-
cial reporting quality, as proxied by earnings response coefficients. Specifically, using a
sample of KAMs disclosed in Taiwanese audit reports (for fiscal years 2016 and 2017), com-
panies with KAMs that contain more client-specific information are perceived as having
lower reporting quality. We further note that this association is driven by the risk-related
description in KAMs. Additional analyses indicate that our textual measure is associated
with actual financial reporting quality, as proxied by abnormal accruals and the likelihood of
misstatements. Overall, our results provide evidence supporting the information value of
KAMs in the Taiwanese audit market. This study contributes by suggesting the value of the
expanded audit report.

Keywords
Key Audit Matters, text analysis, client-specific information, perceived financial reporting
quality

Introduction
The International Auditing and Assurance Standards Board (IAASB) revised auditor report-
ing standards in January 2015 with the intention to enhance the communicative value of
audit reports and the transparency of audits (IAASB, 2015b, 2015c). The most significant
change in the extended audit report is the addition of Key Audit Matters (hereafter, KAMs)
in the auditor’s report (International Standard on Auditing [ISA] 701). The Board argues
that the new KAM reporting requirement provides auditors with a mandate and opportunity

1
National Chengchi University, Taipei
2
University of Kentucky, Lexington, USA

Corresponding Author:
Yu-Tzu Chang, Department of Accounting, National Chengchi University, No. 64, Sec. 2, Zhinan Rd., Wenshan
District, Taipei 11605, Taiwan.
Email: ytc23@nccu.edu.tw
2 Journal of Accounting, Auditing & Finance

to communicate entity-specific information in audit reports beyond the use of uninforma-

tive, standardized language of the traditional audit report. While regulators in many juris-
dictions have enacted expanded audit reports,1 research on market reactions provides mixed
results on the usefulness and informativeness of the expanded auditor’s report (e.g.,
Gutierrez et al., 2018; Reid et al., 2019).
Doubts and concerns about the information value of KAMs motivate the current study.
In this article, we create a new measure of KAM disclosures to examine whether and how
the information content of KAMs influences investor perceptions of financial reporting
quality in the Taiwanese audit market. Specifically, employing emerging methods of text
analysis, we measure the extent of the use of generic versus client-specific content in
KAMs and examine the association between KAM content and perceived financial report-
ing quality, as proxied by earnings response coefficients (ERCs). We consider three possi-
ble relations between KAM disclosures and ERCs. First, if KAMs increase the information
value of audits by conveying firm-specific information to investors, then positive ERCs
should obtain, that is, the ‘‘transparency hypothesis’’ (e.g., Gold et al., 2020; IAASB,
2015b, 2015c). Second, if investors view KAMs with more client- and audit-specific infor-
mation as a signal of greater financial uncertainty and risk of material misstatement in the
audited financial statements, then negative ERCs should obtain, that is, the ‘‘uncertainty
hypothesis’’ (e.g., Kachelmeier et al., 2020; Klevak et al., 2020; Rapley et al., 2021).
Finally, if KAMs are simply standardized disclosures that lack investor information, no
effect on ERCs should obtain.
The results from our ERCs models support the uncertainty hypothesis, suggesting that
KAMs disclosing more client-specific information are associated with lower perceived
earnings quality. We find that this association is mainly driven by the risk information dis-
closed in KAMs, indicating that investors ‘‘value’’ client-specific risk disclosures. This
finding suggests that investors perceive the disclosure of entity-specific KAMs as indicat-
ing greater uncertainty and risk of misstatement. Additional analyses investigate whether
the information content of KAMs is associated with actual financial reporting quality, as
proxied by abnormal accruals and misstatements. Results suggest that KAMs which dis-
close more entity-specific information are (marginally) associated with higher absolute
abnormal accruals and a higher likelihood of a misstatement. In comparisons of the ability
to predict financial reporting quality, our text measures outperform others (i.e., number,
length, and readability of KAMs) in the accrual models. These results suggest that the
information content of KAMs may be better captured by measures of the specificity of
KAM disclosures than measures in the existing literature, which could partially explain
why some studies that examine the number and length of KAMs find insignificant results
(e.g., Gutierrez et al., 2018; Lennox et al., 2021). Our main results are robust to sensitivity
tests using alternative textual measures, that is, calculated using different n-grams and
cutoff criteria.
This study contributes in several ways. First, our findings are relevant to standard set-
ters’ efforts to improve the usefulness of audit reports. Consistent with research suggesting
that the disclosure of KAMs is informative to investors (Goh et al., 2020), we find that the
Taiwanese audit market responds to KAMs that provide client-specific information. Our
finding supports the IAASB’s belief that the inclusion of KAMs in the auditor’s report will
‘‘reinvigorate the auditor’ report . . . , making it more relevant and valuable to investors . . . ’’
(IAASB, 2015a). Second, KAMs should report the significant financial reporting risks that
have been identified and how the auditor has addressed these risks. Our results suggest that
KAMs containing client and engagement descriptions correlate with perceived and actual
Chang et al. 3

financial reporting quality. Our findings are consistent with, and support, the argument that spe-
cificity in risk disclosure is valuable for investors (Campbell et al., 2014; Hope et al., 2016).
Third, this study implies KAMs are a practical mechanism to communicate risk beyond
the traditional audit reports. When client circumstances include significant uncertainty, the
auditor may wish to use KAMs that address heightened risks to alert financial statement
users (cf. Czerney et al., 2014). These findings provide insights into the informativeness of
KAM disclosures that, in turn, contribute to the communication value of the audit report.
With heightened global interest in improving the auditor’s report, our study and related
research promise value to regulators and stakeholders by providing a better understanding
of how auditors convey information to users of financial statements. Finally, the study
applies emerging textual analysis methods to a corpus of KAM disclosures and provides
empirical evidence on the association between textual attributes of KAMs and financial
reporting quality. We further identify and code the content of KAMs as related to (a) risk
assessment (client-specific) or (b) audit procedures (audit-specific). Analysis reveals that
the risk-related KAMs influence investor perceptions of financial reporting quality. This
study responds to the call for the application of text analytics in auditing research (Zhang
et al., 2019). Our results contribute to the academic literature by introducing alternative lin-
guistic measures intended to capture the information content of KAMs, which may be
applied to other financial disclosures.
This article proceeds as follows. The next section provides a background on and context
for the recent audit reporting reforms and the new disclosure requirements. Following this,
we review the related literature and develop our research questions in the section
‘‘Literature Review and Research Question.’’ The section ‘‘Sample and Research Design’’
describes the sample selection process and provides details on the research design.
Empirical results are in the ‘‘Results’’ section, and the article ends with conclusions and
limitations.

Developments in Auditor Reporting and Institutional Background

Among the recent regulatory changes in audit reporting, the requirement found in ISA 701
Communicating Key Audit Matters in the Independent Auditor’s Report is considered the
most significant innovation (PricewaterhouseCoopers, 2015). This standard defines Key
Audit Matters as ‘‘ . . . those matters that, in the auditor’s professional judgment, were of
most significance in the audit of the financial statements of the current period’’ (IAASB,
2015c; ISA 701, Para. 7) and mandates that ‘‘the description of a KAM should be entity-
specific and avoid standardized or technical language’’ (IAASB, 2015a). The IAASB
argues that communicating KAMs in the auditor’s report provides relevant, understandable,
and client-specific information and improves audit disclosures (IAASB, 2015a, 2015c).
Similarly, the Public Company Accounting Oversight Board (PCAOB) also issued a new
auditing standard that requires the auditor’s disclosure of critical audit matters (CAMs;
PCAOB, 2017), which aims to provide investors with relevant information about the spe-
cific audit engagement.2 Proponents of expanded auditor’s reports believe that disclosing
more information related to the audit process, especially about the complex auditor
decision-making process and judgments, will enhance the users’ understanding of the value
of auditing.
4 Journal of Accounting, Auditing & Finance

Auditor Regulation and Reporting in Taiwan

The Financial Supervisory Commission (hereafter, FSC, the Taiwan counterpart to the U.S.
Securities and Exchange Commission [SEC]) is responsible for supervising, regulating, and
examining financial and securities markets in Taiwan. To converge with the new IAASB
audit reporting requirements, the FSC appointed the Accounting Research and
Development Foundation (ARDF) to issue a series of new audit reporting standards, of
which the Statement of Auditing Standards No. 58 (Taiwan SAS No. 58), Communicating
Key Audit Matters in the Independent Auditor’s Report (ARDF, 2016) is the focus of the
current study. ISA 701 and SAS No. 58 require auditors to identify and communicate sig-
nificant risks to financial statement users in the audit report. Auditors shall explain why a
matter was of most significance and was determined as a KAM, how the matter was
addressed in the audit, and to which financial statement disclosure(s) the matter was related
(SAS No. 58, Para. 12). The FSC requires early adoption of the standard for audits of the
listed companies’ financial statements ending on or after December 15, 2016. While the
FSC requires auditors to communicate with ‘‘ . . . those charged with governance . . . ’’
regarding items that the auditor has determined as KAMs (SAS No. 58, Para. 16), the
Taiwanese regulatory reform, unlike that in the United Kingdom, does not require addi-
tional disclosures in the audit committee report.3 Therefore, this difference in the
Taiwanese and the U.K. requirements allows for isolation of the effect of auditor reports,
eliminating the concern related to a large overlap, that is, confound, between audit commit-
tee and auditor reports (Gutierrez et al., 2018).

Literature Review and Research Question

Disclosure of KAMs
Many studies examine the impact of KAM disclosure on stakeholders, including sharehold-
ers, debtholders, external auditors, and the board of directors. The present study’s more
narrow literature review focuses on research that investigates the influence of KAMs on
shareholders and company value.4 Experimental studies generally find evidence of KAM
information value with individual investor participants. For example, researchers find that
the disclosure of KAMs influences investor investment decisions when a KAM discusses a
material account involving complex or subjective auditor judgments (Christensen et al.,
2014). Studies suggest that investors perceive less audit assurance in KAM-related accounts
and use KAM disclosures as a predictor of misstatement risk (e.g., Kachelmeier et al.,
2020; Rapley et al., 2021). Similarly, Kipp and Gaynor (2020) find that the level of disclo-
sure detail in KAMs influences U.S. investors’ perceptions of financial reporting quality,
assessments of likelihood of material misstatement, and investment decisions. Taken
together, these studies, suggesting that KAM disclosure signals heightened risk of material
misstatement, provide experimental evidence that KAM disclosures are informative to
investors.
In contrast to the consistency of the results of experimental research, archival studies
examining the impact of KAMs on shareholder reactions find more heterogeneous results.
Gutierrez et al. (2018), using the data from U.K. companies, find no evidence that the
expanded auditor’s report is associated with changes in proxies for investors’ reaction.
Similarly, Lennox et al. (2021) find no evidence that U.K. investors consider the disclosure
of risks of material misstatement in the expanded audit reports incrementally informative.
Researchers using French (Bédard et al., 2019), New Zealand (Almulla & Bradbury, 2019),
Chang et al. 5

Hong Kong and Chinese (Liao et al., 2019), and U.S. (Burke et al., 2020) data also find no
incremental investor information in the expanded audit report.5 Although it is impossible to
infer that no relationship exists from studies that report null results of hypothesis tests
(Cready et al., in press), one possible explanation for the no-result is that the risk informa-
tion disclosed in expanded auditors’ reports had been previously disclosed in the previous
year’s financial statements or through other disclosure channels (cf. Czerney et al., 2019;
Lennox et al., 2021).
Nevertheless, some studies report that KAM disclosures are value relevant and useful
for investors. For example, Reid et al. (2019) find that the expanded audit report is associ-
ated with improved financial reporting quality (i.e., a decrease in opportunistic earnings
management and an increase in investor perceptions of financial reporting quality) in the
United Kingdom. Klevak et al. (2020), examining U.S. data, also find that firms with more
extensive KAM disclosures have lower market returns and higher volatility of stock returns.
Their results suggest that financial statement users perceive the disclosure of KAMs as an
indicator of uncertainty. Similarly, using data from China, researchers find higher abnormal
trading volume and ERCs, and lower stock price synchronicity after the implementation
of the new audit reporting requirement (Goh et al., 2020), and suggest that the level of
detail in KAMs influences investors’ risk perceptions (Zhou, 2019). Taken together, the lit-
erature provides mixed results on the usefulness and informativeness of KAMs, possibly
due to different research designs and country-specific regulatory regimes and disclosure
requirements.6
This study extends the emerging literature on KAMs and differs from prior research in
two important ways. First, we examine the impact of KAMs using a cross-sectional analy-
sis in the postadoption period, instead of a within-firm, pre- to postadoption period compar-
ison. This design triangulates existing research and allows for exploration of whether and
how the heterogeneity in KAM disclosures influences investor perceptions. Second, we
create a text measure to capture which KAM language is ‘‘generic’’ versus client-specific.
We expect this measure to better capture variability in KAM content compared with other
widely used proxies such as the number and the length of KAMs. Next, we propose the
research questions investigating the impact of KAM disclosures on perceptions of financial
reporting quality.

Content of the KAM Disclosure: Generic Versus Client-Specific Information

A common criticism of the standardized auditor’s report is that it provides little entity-
specific information because it reports a standardized, dichotomous opinion using boiler-
plate language (legalese; Bédard et al., 2016; Mock et al., 2013). To enhance the value of
the audit report and improve audit quality, the IAASB argues that ‘‘ . . . the nature of mat-
ters that are likely most important to users will differ from entity to entity’’ (IAASB, 2012,
p. 6) and encourages auditors ‘‘ . . . to be as entity-specific and audit-specific as possible in
the description of a KAM’’ (IAASB, 2015a, p. 4). The new reporting standard seeks to
broaden the scope of the auditor’s report by including KAMs that deliver firm-specific
information to investors, leading to increased audit transparency, financial reporting, and
audit quality (Financial Reporting Council, 2013; IAASB, 2015b, 2015c, 2015d; PCAOB,
2017). Academics also suggest that greater transparency through KAMs improves manage-
rial accountability and financial reporting quality (Gold et al., 2020).7 Hence, we expect
that KAMs that provide ‘‘non-generic’’ information, for example, specific facts and cir-
cumstances of the client and engagement, should enhance perceived audit transparency,
6 Journal of Accounting, Auditing & Finance

leading to higher perceived financial reporting quality, that is, the transparency hypothesis.
In contrast, ‘‘generic’’ disclosures will not influence perceived financial reporting quality.
Alternatively, KAM disclosures may indicate uncertainty and heightened risk of material
misstatement in the audited financial statements (Kachelmeier et al., 2020; Klevak et al.,
2020; Vinson et al., 2019). Smith (2021) provides textual evidence that expanded audit
reports may signal increased risk and uncertainty through more use of uncertain and nega-
tive words. When KAM disclosures signal significant client risks identified during the
audit, investors are likely to discount management disclosure credibility and reduce their
investment intentions (Christensen et al., 2014; Rapley et al., 2021). Furthermore, informa-
tion processing theory and source credibility research suggest that investors are more likely
to integrate more concrete and specific information—perhaps includes client- and audit-
specific KAMs—into investment decisions. Hope et al. (2016) find that more specific risk
disclosure leads to larger market reactions, which they posit results from increased informa-
tion processing that enhances investors’ risk assessments. Hence, we expect that KAMs
which provide more client-specific information are associated with lower perceived finan-
cial reporting quality, through increases in investor perceptions of both risk of material mis-
statement and management disclosure credibility, that is, the uncertainty hypothesis.
However, a third possibility is that, if KAMs mostly contain standardized language (i.e.,
‘‘boilerplate’’) or report previously disclosed information, then the disclosure of KAMs
may not be associated with perceptions of financial reporting quality.
Based on the three models that we articulate above, our first research question is stated
as a simple test of whether KAMs signal perceived financial reporting quality:

Research Question 1 (RQ1): Are KAMs that provide client-specific information

associated with the perceived quality of financial reporting?

Nature of the KAM Disclosure: Risk Assessment Versus Audit Procedure

KAM descriptions should provide insight as to why the matter is considered significant
(i.e., risk assessment) and what approach the auditor took to address the matter (i.e., audit
procedure) (ISA 701 Para. 13; SAS No. 58 Para. 12). The inclusion of the auditor’s risk
assessment in a KAM is likely to inform financial statement users by facilitating their
understanding of auditor judgments. Standards also require the KAM to describe how the
auditor addressed the issue in the audit by summarizing the auditor’s response to the
matter, and by providing a brief overview of procedures performed, or key audit observa-
tions with respect to the matter. The description of the nature and extent of the audit proce-
dures performed should, when possible, provide insight into entity-specific circumstances,
economic conditions, or industry developments.
As discussed, we speculate that KAMs with more client-specific information are associ-
ated with higher (lower) perceived financial reporting quality through the perception of
increased transparency (increased risk and uncertainty) of an audit. The transparency
hypothesis predicts that both risk-related and procedure-related descriptions are associated
with the higher perceived financial reporting quality. In contrast, the uncertainty hypothesis
predicts that the description related to risk assessment, but probably not the description
related to audit procedures, will be associated with lower perceived financial reporting
quality. Our rationale for this speculation is that the risk-related description of KAMs is
more likely to reveal heightened client uncertainty and significant risks while the
Chang et al. 7

procedure-related description of KAMs addresses the auditor’s response to such risks. As

such, our research questions are as follows:

Research Question 2 (RQ2): Are KAM disclosures related to risk assessment

(RQ2a) or audit procedures (RQ2b) associated with the perceived quality of finan-
cial reporting?

Sample and Research Design

Sample Selection
Our sample includes audit reports issued for 2016 and 2017 financial statements of listed
companies in Taiwan. From the Taiwan Economic Journal (TEJ) database, we harvested
3,829 auditor reports with corresponding financial statements. After dropping 370 observa-
tions in the financial services industry and 566 observations with missing control variables,
the final sample size is 2,893 audit reports. The reports contained a total of 6,464 KAMs,
with an average number of 2.08 KAMs reported per company and the maximum number of
five KAMs. The average KAM section has about 851 words, with an interquartile range of
634 to 1,033 words.

Multivariate Model and Measures

Following Ghosh and Moon (2005) and Chi et al. (2009), we use the ERC estimated from
concurrent returns-earnings regressions as a market-based proxy for investor perceptions of
financial reporting quality. Specifically, we estimate the following model to test the
research questions:

CAR = a + b1 E + b2 DE + b3 KAMGeneric + b4 E 3 KAMGeneric + b5 DE 3 KAMGeneric + CV

ð1Þ
+ E 3 CV + DE 3 CV + YearFE + IndustryFE + e:

CAR is cumulative market-adjusted abnormal returns for the 12 months ending 3 months
after the fiscal year-end. Market-adjusted abnormal returns are the difference between raw
returns and value-weighted market returns. E and DE represent levels of and changes in
income from continuing operations, both scaled by the market value of equity at the begin-
ning of the year. To test RQ1, we create KAMGeneric to measure the degree of the ‘‘gen-
eric’’ (i.e., not client specific) language used in KAMs. Following Lang and Stice-
Lawrence (2015), we identify four-word phrases (called ‘‘tetragrams’’) at the Chinese char-
acter level, in a client firm’s industry, as generic KAM phrases. After counting all tetra-
grams in the KAMs and aggregating them by industry, we keep the tetragrams that occur
in 30% of the KAMs in an industry and exclude common grammatical phrases that
appear in 85% of those KAMs in the industry. The variable, KAMGeneric, is thus calcu-
lated as the percentage of generic tetragrams (the number of tetragrams identified as gen-
eric phrases divided by the total number of tetragrams) in the KAM section.8 Hence, a
company with KAMs that are common to its industry has a larger value of KAMGeneric (i.e.,
containing less client-specific information). The primary interest of RQ1 focuses on the
sum of the coefficients on E 3 KAMGeneric and DE 3 KAMGeneric (b4 + b5). If KAMs that
disclose more specific client information improve the transparency of audits, we would
8 Journal of Accounting, Auditing & Finance

expect to see an increase in ERC, that is, (b4 + b5) \ 0. Alternatively, if the disclosure of
KAMs with more specific client information is perceived to signal uncertainty and heigh-
tened risk of material misstatement, we would expect to see a decrease in ERC, that is, (b4 +
b5) . 0.
To test RQ2, we first classified the content of a KAM as either risk-related or audit-
procedure-related, and then repeated the above procedures to create two textual measures,
KAMGenRisk and KAMGenAP, which capture generic language in the descriptions of risk
assessment and audit procedure, respectively. Specifically, the content of a KAM is classi-
fied as risk-related if the description indicates why the matter was deemed most significant
in the audit and therefore determined to be a KAM, or as audit-procedure-related if the
description indicates how the matter was addressed in the audit.9 Likewise, the primary
interests of RQ2a and RQ2b focus on the sum of the coefficients on E 3 KAMGenRisk and
DE 3 KAMGenRisk and that on E 3 KAMGenAP and DE 3 KAMGenAP, respectively.
Following prior studies (for consistency), we include control variables and their respec-
tive interactions with earnings levels (E) and earnings changes (DE) in Model (1). The list
of control variables includes SIZE, the natural logarithm of market value of equity; GRW,
the percentage of sale growth from prior year; LEV, the ratio of total debt to total assets;
LOSS, an indicator variable equal to 1 if the company’s net income is less than 0;
EARNVOL, the standard deviation of the EBITDA (earnings before interest, taxes, depreci-
ation, and amortization), computed over the preceding 5 fiscal years (over t – 5 through
t – 1); BETA, a slop coefficient calculated using the market model with the past 36 monthly
returns; TENURE, the cumulative number of years, which the audit firm audited the current
company from 1983 or the year the company was established, whichever is later; and
BIG4, an indicator variable equals 1 if the company is audited by a Big4 audit firm, and 0
otherwise. Finally, we control for fixed effects by year and industry (YearFE and
IndustryFE). The complete list of variable definitions is provided in the appendix.

Interview With Audit Partners—Insights Into the Reporting Experience of KAMs

in Taiwan
To better understand audit firm practices in reporting KAMs in Taiwan, we conducted
semistructured interviews with four Taiwanese audit partners from two Big4 audit firms.10
Consistent with the expectations of the FSC, the interviewees generally believed that KAM
reporting improves the usefulness and informative value of the audit report. Partner A
(Audit Firm 1) believed that the expanded audit report provides more information as the
auditor could communicate in KAMs about critical accounting estimates and significant
matters arising during the audit. Partner B (Audit Firm 2) specified that ‘‘KAMs should be
specific’’ to be informative and ‘‘each company should have different KAMs.’’ The inter-
viewees also agreed that KAMs are a practical mechanism to communicate risk beyond tra-
ditional audit reports. Partner C (Audit Firm 2) indicated that KAMs should clearly address
auditors’ assessments of risks of material misstatement and corresponding response to an
identified matter. In addition, Partner D (Audit Firm 1) emphasized the importance of
using precise risk descriptions in KAMs to communicate client-specific information to
financial statement users.
We further asked what KAM information is most valued by financial statement users.
The interviewees indicated that they had received questions from audit committee mem-
bers, shareholders, or bankers regarding areas in the financial statements that were
Chang et al. 9

addressed in KAMs.11 Partner B indicated that while sophisticated or institutional investors

are more likely to read and understand KAMs, the reporting of KAMs helps users of finan-
cial statements who have little financial knowledge to focus on the most significant risks
identified by the auditor. Similarly, Partner D pointed out that professional investors are
more likely to inquire about the content of KAMs (especially KAMs that are uncommon to
the industry of the client), while nonsophisticated investors are often more concerned more
about the quantity (than the content) of KAMs. She further suggested that nonprofessional
investors are likely to perceive KAMs as ‘‘a negative signal’’ of firm performance. As for
the usefulness of KAMs, Partner B highlighted the importance of client-specific KAMs on
professional investors’ decision making. Partner D believed that ‘‘technical terms used in
KAMs may decrease the usefulness of KAMs to average investors.’’ All interviewees
agreed that stakeholders attend more to the risk-related descriptions in KAMs; however,
they doubted whether most stakeholders understand audit procedures reported in KAMs.
Partner C mentioned that regulators (i.e., the FSC) or peer reviewers are more likely to
assess the audit-procedure-related KAM description than are other stakeholders.
To understand whether audit partners use standardized language in KAM reporting, we
asked about the use of template in audit firms. All interviewees indicated that, in the first
year of the implementation of KAMs, their firms provided workpaper templates for identi-
fying KAMs and some examples of KAMs issued by Big4 firms in the United Kingdom.
However, no standardized templates were required for KAM reporting. Interestingly,
Partner B mentioned that each Big4 has its own audit style that influences its KAM report-
ing. In summary, shareholders are believed to find risk-related KAM disclosures more
informative than audit-procedure-related KAM disclosures. However, such disclosures are
most likely to benefit stakeholders with finance and accounting knowledge rather than less
knowledgeable stakeholders.

Results
Descriptive Statistics
Table 1 provides descriptive statistics for the variables used in the model. The mean of
stock returns CAR (0.045), earnings E (0.05), and earnings change DE (0.013) are all posi-
tive, indicating good earnings and stock performance. The variable of interest, KAMGeneric,
has a mean value of 0.079, indicating that, on average, 8% of a KAM’s content is identified
as generic (i.e., nonspecific) language in our measure.12 The mean values of KAMGenRisk
and KAMGenAP are 0.062 and 0.055, respectively. The mean value of LOSS is 0.223, indi-
cating that about 78% of our sample has positive earnings performance. The average firm
tenure is 16 years, and about 88% of the client firms are audited by Big4 auditors. The
descriptive statistics of all other variables are comparable with those obtained in prior
research (e.g., Baber et al., 2014; Chi et al., 2009). Correlations (untabulated) among the
independent variables used in the model are low to moderate (i.e., below .42), except for
the correlation between E and LOSS, which is –.714. Multicollinearity diagnostics indicate
that most variance inflation factors (VIFs) are below the acceptable level (i.e., 10), except
those for E 3 SIZE and DE 3 SIZE. Sensitivity analysis in which we exclude LOSS or
SIZE does not change the results reported later. We thus conclude that multicollinearity is
not driving our results.
10 Journal of Accounting, Auditing & Finance

Table 1. Descriptive Statistics (N = 2,893).

Variable M SD Q1 Median Q3
CAR 0.045 0.340 –0.158 –0.013 0.184
E 0.050 0.113 0.008 0.059 0.106
DE 0.013 0.103 –0.026 0.002 0.035
KAMGeneric 0.079 0.030 0.058 0.075 0.095
KAMGenRisk 0.062 0.034 0.038 0.054 0.079
KAMGenAP 0.055 0.026 0.036 0.052 0.069
SIZE 8.225 1.379 7.267 8.067 9.034
GRW 0.096 1.750 –0.087 0.010 0.111
LEV 0.410 0.181 0.270 0.411 0.538
LOSS 0.223 0.417 0.000 0.000 0.000
EARNVOL 0.044 0.047 0.017 0.029 0.052
BETA 1.053 0.682 0.583 1.007 1.451
TENURE 16.010 8.437 9.000 16.000 22.000
BIG4 0.873 0.332 1.000 1.000 1.000

Note. All the continuous variables are winsorized at 1% and 99% to mitigate the effect of outliers. See variable
definitions in the appendix.

Regression Analysis
Table 2 shows the results of ordinary least squares (OLS) earnings response regressions. In
Column (1), we test RQ1 that explores whether the extent of client-specific information of
KAMs is associated with perceived quality of financial reporting. The impact of
KAMGeneric on ERCs is significant and positive (coefficient = 5.191, F-statistic = 3.81, p =
.051). Consistent with the uncertainty hypothesis, that is, that KAM disclosure represents
increased risk and uncertainty, this finding suggests that KAMs disclosing a greater extent
of client-specific information are perceived as associated with lower earnings quality. We
test RQ2 in Columns (2) to (4) and find that the impact of KAMGeneric on ERCs is mainly
driven by the impact of KAMGenRisk: coefficients in Column (2) = 4.874, F-statistic = 3.96,
p = .046; coefficients in Column (4) = 3.866, F-statistic = 3.13, p = .095. These results pro-
vide some evidence that companies with KAMs containing industry unique risk descrip-
tions are perceived as indicating lower earnings quality. A possible reason that we do not
find results on KAMGenAP is that investors may ignore or fail to understand the audit proce-
dures described in KAMs. Results (untabulated) on our control variables are consistent
with those reported in prior studies.13 Overall, our findings suggest that investors perceive
the disclosure of entity-specific KAMs as a warning of areas posing heightened uncertainty
and risk of misstatement.

Additional Analysis
Quantity of KAMs. Several studies examine the number and the length of KAMs disclosed
in the audit report (Almulla & Bradbury, 2019; Bédard et al., 2016; Gutierrez et al., 2018;
Reid et al., 2019). We re-perform the main analysis to explore whether the number of
KAMs (KAMNum) and the length of the KAM section (KAMWC) are association with ERCs.
KAMNum is measured as the number of paragraphs of KAMs disclosed in the auditor’s
report, and KAMWC is the natural logarithm of the total word count of KAMs disclosed in
Chang et al. 11

Table 2. Test of RQ1 and RQ2—The Impact of KAMs on ERCs (N = 2,893).

DV = CAR
Variables Coefficient (1) (2) (3) (4)
E b1 0.592 0.485 0.549 0.482
(0.962) (0.808) (0.916) (0.950)
DE b2 1.112* 1.269** 1.390** 1.166*
(1.689) (1.963) (2.195) (1.782)
b1 + b2 1.704** 1.753*** 1.938*** 1.648**
[6.40] [7.56] [8.88] [7.02]
KAMGeneric b3 –0.026
(–0.104)
E 3 KAMGeneric b4 0.063
(0.029)
DE 3 KAMGeneric b5 5.128**
(1.993)
b4 + b5 5.191**
[3.81]
KAMGenRisk b3R 0.178 0.222
(0.749) (1.393)
E 3 KAMGenRisk b4R 0.822 0.635
(0.359) (0.456)
DE 3 KAMGenRisk b5R 4.052* 3.231
(1.695) (1.476)
b4R + b5R 4.874** 3.866*
[3.96] [3.13]
KAMGenAP b3AP –0.077 –0.164
(–0.284) (–1.113)
E 3 KAMGenAP b4AP 0.612 0.468
(0.256) (0.287)
DE 3 KAMGenAP b5AP 4.218 2.684
(1.341) (0.802)
b4AP + b5AP 4.829 3.152
[2.40] [2.10]
Constant –0.189*** –0.203*** –0.190*** –0.199***
(–2.633) (–2.867) (–2.676) (–4.840)
Control variables Included Included Included Included
YearFE Yes Yes Yes Yes
IndustryFE Yes Yes Yes Yes
Adjusted R2 .222 .223 .222 .222

Note. All the continuous variables are winsorized at 1% and 99% to mitigate the effect of outliers. See variable
definitions in the appendix. RQ1 = Research Question 1; RQ2 = Research Question 2; KAMs = Key Audit
Matters; ERCs = earnings response coefficients; DV = dependent variable, FE = Fixed Effects.
***,**, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively, for a two-tailed t-statistic
(in parentheses) and a two-tailed F-statistic [in brackets].

the auditor’s report. In addition, we measure the word count for the description of risk
assessment and that of audit procedure (KAMWCRisk and KAMWCAP, respectively). All con-
trol variables are included and defined as in the previous section. Table 3 reports the
results: The impact of KAMNum (coefficient = 20.245, F-statistic = 24.49) and KAMWC
(coefficient = 20.364, F-statistic = 23.35) on ERCs is negative at the 5% and 10% levels
12
Table 3. The Impact of Textual Attributes (Number, Length, and Readability) of KAMs on ERCs (N = 2,893).

DV = CAR

Variables Coefficient (1) (2) (3) (4) (5) (6) (7)

E b1 0.558 0.164 0.852 –0.058 0.420 1.106 0.162
(1.006) (0.148) (0.972) (–0.061) (0.649) (1.216) (0.188)
DE b2 1.975*** 4.320*** 3.228*** 3.644*** 2.503*** 3.329*** 2.712***
(3.195) (3.414) (3.175) (3.507) (3.236) (2.947) (2.716)
(E + DE) b1 + b2 2.534*** 4.484*** 4.081*** 3.586*** 2.923*** 4.435*** 2.874***
[17.22] [10.82] [15.68] [10.05] [14.21] [13.84] [8.18]
(E + DE) 3 KAMNum b4Num + b5Num –0.245**
[–4.49]
(E + DE) 3 KAMWC b4WC + b5WC –0.364*
[–3.35]
(E + DE) 3 KAMWCRisk b4WCRisk + b5WCRisk –0.365**
[–4.75]
(E + DE) 3 KAMWCAP b4WCAP + b5WCAP –0.257
[–1.93]
(E + DE) 3 KAMCRIE b4CRIE + b5CRIE –0.123
[–1.74]
(E + DE) 3 KAMCRIERisk b4CRIERisk + b5CRIERisk –0.465**
[–4.67]
(E + DE) 3 KAMCRIEAP b4CRIEAP + b5CRIEAP –0.135
[–0.58]
Constant –0.189*** –0.105 –0.156* –0.110 –0.135* –0.158 –0.099
(–2.835) (–0.905) (–1.661) (–1.096) (–1.762) (–1.450) (–1.027)
Control variables Included Included Included Included Included Included Included
YearFE Yes Yes Yes Yes Yes Yes Yes
IndustryFE Yes Yes Yes Yes Yes Yes Yes
Adjusted R2 .224 .224 .224 .223 .223 .223 .222

Note. All the continuous variables are winsorized at 1% and 99% to mitigate the effect of outliers. See variable definitions in the appendix. KAMs = Key Audit Matters; ERCs =
earnings response coefficients; DV = dependent variable, FE = Fixed Effects.
***,**, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively, for a two-tailed t-statistic (in parentheses) and a two-tailed F-statistic [in brackets].
Chang et al. 13

in Columns (1) and (2), respectively. The result suggests that investors perceive companies
with more KAMs disclosed (in number and in length) as having lower earnings quality.
Results in Columns (3) and (4) indicate that the impact of KAMWC on ERCs is mainly
driven by KAMWCRisk, that is, the length of the KAM risk description.

Readability of KAMs. We next consider the effect of the complexity of KAMs on ERCs.
Critics argue that audit reports are unreadable and hold little relevance to stakeholders’
decisions (Dillard & Jensen, 1983; Fakhfakh, 2015; Pound, 1981). The value of KAMs
would likely be reduced if the disclosures use technical language that is not understandable
to stakeholders (cf. Asare & Wright, 2012; Footprint Consultants, 2011). We predict that a
company’s reporting quality is perceived as low when its reported KAMs are less readable.
We adopt the Chinese Readability Index Explorer (CRIE) to calculate our readability mea-
sure of KAMs, KAMCRIE, denoting that the higher the value, the more difficult the text.14
We also create KAMCRIERisk and KAMCRIEAP to measure the readability of KAMs related to
risk assessment and audit procedure, respectively. While Column (5) of Table 3 shows that
the impact of KAMCRIE on ERCs is not significant, Column (6) indicates that the impact of
KAMCRIERisk on ERCs is significantly positive at the 5% level (coefficient = 20.465,
F-statistic = 24.67). The result suggests that investors may perceive a company as having
lower financial reporting quality when its risk description of KAMs is less readable.
Consistent with the main analysis, results from different text measures also suggest that
KAMs, especially in the disclosure of risk assessment, inform investors.

Actual financial reporting quality. We next examine whether the information content of
KAMs is associated with two proxies of actual financial reporting quality. The first proxy,
the absolute value of abnormal accruals (|DA|), is estimated using the modified Jones
model of discretionary accruals with control for contemporaneous performance (Kothari
et al., 2005). The second proxy, MISSTATE, is a dummy variable equal to 1 if the firm-
year financial statements have been amended from the original filing, and 0 otherwise.
Both proxies are inverse measures of financial reporting quality. As in prior studies, we
control for several additional variables, including CFO, ROA, TenurePtr, and ExpertPtr
(see the appendix). As shown in Table 4, results for the accrual model in Column (1) and
for the misstatement model in Column (3) indicate that the coefficients on KAMGeneric are
negative and significant at the 5% and 10%, respectively. These results suggest that KAMs
containing entity-specific information that is uncommon to the industry of the company are
associated with poor financial reporting quality. Furthermore, we compare the predictive
value of the text KAM measures. Results in Column (2) show that KAMGeneric predicts
abnormal accruals better than do other text measures (i.e., number, length, and readability
of KAMs), suggesting that the information content of KAMs may be better captured by
KAMGeneric compared with measures in prior studies. This finding may partially explain
why prior studies that examine the number and length of KAMs do not find significant
results (e.g., Gutierrez et al., 2018; Lennox et al., 2021). However, we do not find signifi-
cant associations between the three text measures and the likelihood of misstatement in
Column (4).

Audit fees. We investigate the association between audit fees and the KAM measures.15
Results in Columns (5) and (6) of Table 4 suggest that KAMGeneric is negatively associated
with FEES and better predicts audit fees than do other text measures. The finding that
14 Journal of Accounting, Auditing & Finance

Table 4. Actual Financial Reporting Quality and Comparison of Measures of KAMs.

DV = |DA| DV = MISSTATE DV = FEES

Variables (1) (2) (3) (4) (5) (6)
KAMGeneric –0.073** –0.075** –3.128* –2.956 –1.545*** –1.292***
(–2.130) (–2.023) (–1.816) (–1.643) (–5.670) (–4.557)
KAMNum 0.001 –0.102 –0.023
(0.416) (–0.799) (–1.043)
KAMWC –0.005 0.321 0.095
(–0.933) (1.020) (1.900)
KAMCRIE 0.002 –0.096 –0.007
(0.804) (–0.781) (–0.324)
Constant 0.063*** 0.084*** –1.321*** –2.684* 5.776*** 5.226***
(6.994) (3.104) (–3.090) (–1.769) (58.321) (21.119)
Control variables Included Included Included Included Included Included
YearFE Yes Yes Yes Yes Yes Yes
IndustryFE Yes Yes Yes Yes Yes Yes
Observations 3,107 3,107 2,876 2,876 2,393 2,393
Adjusted R2 .113 .113 .609 .610
x2 54.38 58.38

Note. All the continuous variables are winsorized at 1% and 99% to mitigate the effect of outliers. See variable
definitions in the appendix. KAMs = Key Audit Matters; DV = dependent variable, FE = Fixed Effects.
***,**, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively, for a two-tailed t-statistic
(in parentheses) in Columns (1), (2), (5), and (6) and z-statistic (in parentheses) in Columns (3) and (4).

companies with uncommon risks pay higher fees is consistent with the argument that audit
fees contain a premium for client-specific risk, that is, risk premiums (e.g., Jiang & Son,
2015).

Conclusion
The new reporting requirement expands auditor reports beyond the current boilerplate audit
opinion. This study extends the prior literature by documenting evidence indicating that
auditors can signal client-specific risks with KAMs. Results suggest that the extent of
client-specific risk information disclosed in KAMs is associated with investors’ perceptions
of financial reporting quality. Our finding supports that risk-related auditor disclosures
attract investors’ attention and improve the usefulness of audit reports (Czerney et al.,
2019).
Our conclusions are subject to important caveats. First, the inferences from the results
are based on a key assumption that KAMs with less generic language contain more client-
specific risk information, given that the new reporting standard allows audit firms broad
discretion over the content and extent of KAM reports. While this assumption is consistent
with regulators’ expectations (IAASB, 2012; PCAOB, 2017), generic KAM language might
be unavoidable for some risks. For example, some risks are common to industries, for
example, technology product revenue recognition, and hence may result in a ‘‘generic’’
KAM disclosure. Second, text analytic measures of accounting and auditing documents are
emergent. Existing measures may not have been validated in a large number of accounting
and auditing-relevant settings or may not have been replicated across contexts and settings.
Chang et al. 15

While we largely adopt the approach of Lang and Stice-Lawrence (2015) in measuring tex-
tual attributes, our corpus differs from theirs. Hence, to check for robustness, we employ
alternative measures to perform sensitivity analysis. While the measures appear reasonable
and the results are consistent with the main analysis, they are exploratory and will benefit
from testing, validation, and replication.
Notwithstanding the above limitations, our results should be of interest to regulators,
standard setters, investors, and other researchers regarding the value and possibilities of
expanded auditor disclosures. Future research can further examine influences on changes in
KAMs or on the evolving auditor’s report and its associations with KAM reporting. Our
results suggest promises and opportunities exist for improved audit reporting.

Appendix. Variable Definitions.

Variables Definition
Dependent variables
CAR Cumulative market-adjusted abnormal returns for the 12 months ending 3
months after the fiscal year-end. Market adjustment based on value-weighted
market return.
|DA| Absolute value of abnormal accruals calculated based on the performance-
adjusted modified Jones model.
FEES The natural logarithm of audit fees.
MISSTATE An indicator variable equal to 1 if the firm-year financial statements have been
amended from the original filing, and 0 otherwise.
Textual variables
KAMGeneric The percentage of generic tetragrams (the number of tetragrams identified as
generic phrases divided by the total number of tetragrams) in the Key Audit
Matter (KAM) section.
KAMGenRisk The percentage of generic tetragrams calculated based on the risk
descriptions in KAMs, which indicate why the matter was deemed most
significant in the audit and therefore determined to be a KAM.
KAMGenAP The percentage of generic tetragrams calculated based on the audit-
procedure descriptions in KAMs, which indicate how the matter was
addressed in the audit.
KAMNum The number of paragraphs of KAMs disclosed in the auditor’s report.
KAMWC The natural logarithm of the total word count of KAMs.
KAMWCRisk The natural logarithm of the word count of the risk descriptions in KAMs.
KAMWCAP The natural logarithm of the word count of the audit-procedure descriptions
in KAMs.
KAMCRIE The readability measurement calculated based on the entire section of KAMs.
The readability formula = 4.53 + 0.01 3 [Difficult words] – 0.86 3 [Simple
sentence ratio] – 1.45 3 [the logarithm of content word frequency] + 0.02 3
[Personal pronouns].
KAMCRIE_R The readability measurement calculated based on the risk descriptions in
KAMs.
KAMCRIE_AP The readability measurement calculated based on the audit-procedure
descriptions in KAMs.
KAMn-grams Alternative textual measures that are calculated as the number of n-grams
(n = 2 and 3) identified as generic phrases divided by the total number of
n-grams.
(continued)
16 Journal of Accounting, Auditing & Finance

Appendix. (continued)
Variables Definition
LSL The percentage of words in KAMs from flagged sentences (i.e., the number of
words from flagged sentences divided by the total number of words in
KAMs; cf. Lang & Stice-Lawrence, 2015)
Control variables
ARINV Inventory and receivables divided by total assets.
BETA Systematic risk calculated using market model with the past 36 monthly
returns.
BIG4 An indicator variable equals 1 if the company is audited by a Big4 audit firm,
and 0 otherwise.
CFO Cash from operations from the statement of cash flows in year t, scaled by
total assets at the beginning of year t.
E Levels of income from continuing operations, scaled by the market value of
equity at the beginning of the year.
DE Changes in income from continuing operations, scaled by the market value of
equity at the beginning of the year.
EARNVOL The standard deviation of the EBITDA (earnings before interest, taxes,
depreciation, and amortization), computed over the preceding 5 fiscal years
(over t – 5 through t – 1).
ExpertPtr Market share of the audit partner in a given industry in year t, measured as
the total assets of audited clients in an industry divided by the total assets of
all companies in that industry (as shown in percentage).
GC An indicator variable equals 1 if the auditor issued a going concern opinion,
and 0 otherwise.
GRW The percentage of sale growth from prior year.
LEV Total debt divided by total assets.
LOSS An indicator variable equals 1 if the company’s net income is less than 0, and
0 otherwise.
NSEG The natural logarithm of one plus the number of financial segments.
ROA Earnings before extraordinary items in year t, scaled by total assets at the
beginning of year t.
SIZE The natural logarithm of market value of equity (in millions).
TENURE The cumulative number of years, which the audit firm audited the current
company from 1983 or the year the company was established, whichever is
later.
TenurePtr The cumulative number of years that the audit partner audited the current
client.
YearFE Year indicator.
IndustryFE Industry indicator.

Authors’ Note
A previous version of this article was titled ‘‘The Effect of Client-Specific Experience on the
Disclosure Quality of Key Audit Matters (KAMs): Evidence From Taiwan.’’

Acknowledgments
We are grateful for the valuable comments and suggestions received from Bharat Sarath (the Editor)
and the anonymous reviewer. We also appreciate the comments of Scott Seavey (discussant), Ming-
Chin Chen, Vincent Chen, Lynette Chou, Hung-Chao Yu, and workshop participants at the 2018
Chang et al. 17

American Accounting Association (AAA) Annual Meeting, the 2018 European Accounting
Association (EAA) Annual Meeting, and the National Chengchi University. We also thank Chih-Ying
Chen, Chris Hogan, and Miguel Minutti-Meza for helpful comments and suggestions.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/
or publication of this article.

Funding
The author(s) disclosed receipt of the following financial support for the research, authorship, and/or
publication of this article: Dan N. Stone thanks the Von Allmen School of Accountancy, the Gatton
College of Business, and the University of Kentucky for financial support. Yu-Tzu Chang gratefully
acknowledges financial support from Ministry of Science and Technology (Project No. MOST 106-
2410-H-004-041-MY2).

ORCID iD
Yu-Tzu Chang https://orcid.org/0000-0001-8991-3671

Supplemental Material
Supplemental material for this article is available online.
Notes
1. Many jurisdictions have implemented some form of Key Audit Matter (KAM) disclosure require-
ments, including Australia, Brazil, China, Hong Kong, Malaysia, New Zealand, Singapore, the
United Kingdom, and the United States.
2. While the International Auditing and Assurance Standards Board (IAASB, 2013) and the Public
Company Accounting Oversight Board (PCAOB, 2013) use slightly different terminology for
these matters (i.e., KAMs and critical audit matters, respectively), they are conceptually similar.
For expositional convenience, we adopt the IAASB’s terminology throughout this article.
3. In Taiwan, audit committees are not mandated for listed companies. As of June 2018, the propor-
tion of listed companies that have an audit committees was 60.41% for companies listed on
Taiwan Stock Exchange (TWSE) and 39.55% for companies listed on Taipei Exchange (TPEx)
(Securities and Futures Institute, 2018). In our sample, about 37% of observations have audit
committees, of which the average number of audit committee members is three. Our results are
robust when controlling for the presence or number of audit committees.
4. Please refer to Online Appendix 1 for a summary of the studies that we review in our literature
review.
5. Bédard et al. (2019) examine the disclosure of justifications of assessments (JOAs) in French
audit reports. Like KAMs, JOAs serve the purpose to enhance the informative value of audit
reports. They find no association between the disclosure of JOAs and investors’ reaction as mea-
sured by abnormal returns and abnormal trading volume.
6. For example, while Gutierrez et al. (2018) and Reid et al. (2019) both use the U.K. data, they
employ different research designs (a difference-in-differences research design that compares two
groups of firms with different auditor’s report requirements vs. a balanced panel design where
each compliance firm is used as its own control in addition to employing European and U.S. con-
trol groups). In addition, the results of archival studies using data from specific countries (i.e.,
the United Kingdom, Hong Kong, French, and New Zealand), including the present study, are
subject to country-specific effects of the equity market and socioeconomic environment (cf.
Velte & Issa, 2019).
18 Journal of Accounting, Auditing & Finance

7. In an experimental study, Gold et al. (2020) examine and find that KAMs serve as a mechanism
for enhancing financial reporting quality by mitigating aggressive financial reporting behavior.
Our study differs from theirs as we use archival data to investigate the effect of the information
content, rather than the presence, of KAMs on perceived financial reporting quality. Gold et al.
(2020) also manipulate the informational precision of KAMs (firm-specific vs. nonfirm-specific
information) but do not find that specificity in risk disclosure influences managers’ reporting.
Our study, unlike theirs, focuses on investors’ reactions.
8. Because the documents in our sample are much shorter, that is, the average document length in
Lang and Stice-Lawrence’s sample is about 19 times greater than ours, we modified their mea-
sure in two ways. First, we inspected the tetragrams and identified ‘‘innocuous’’ common
phrases as those that appeared in more than 85% of the KAM reports in an industry. We then
excluded those phrases across documents. To test the robustness of our measure, we adopted
alternative cutoff rules (i.e., a range of 30%–90%, 40%–85%, and 40%–90%). Results are
mainly unchanged. Second, our calculation of the text measure differs from Lang and Stice-
Lawrence. Specifically, they flag sentences that contain at least one generic phrase and calculate
their boilerplate measure as the percentage of words in the KAMs from sentences that contain at
least one generic phrase. Please refer to Online Appendix 2 for a demonstration of our measure-
ment calculation. See Online Appendix 3 for a sensitivity analysis in which we rerun the model
using alternative textual measures (i.e., bigrams and trigrams, Lang and Stice-Lawrence’s mea-
sures) to validate the findings. Our results are mainly unchanged.
9. Three accounting master’s students classified KAMs into risk and audit-procedure functions. The
coders followed the authors’ coding instructions which included comparing and verifying each
other’s coding. For disagreements, one of the authors served as a judge to resolve inconsistencies.
10. Interviews, with three male and one female partner, were conducted online (via zoom or Webex)
in Mandarin Chinese and translated into American English by two authors who are native
Mandarin Chinese speakers. A native speaking English co-author reviewed the translations of the
interviews. The interview protocol asked participants about their views of and experience with
KAM reporting. During interviews, the interviewer summarized and restated interviewees’ state-
ments to confirm that understanding of the discussed issues. At the end of the interviews, partici-
pants were asked whether there were related issues that were important but undiscussed. Please
refer to Online Appendix 4 for the interview script.
11. For example, Partner A had received questions such as ‘‘why did the auditor report this matter as
a KAM?’’; ‘‘Did the auditor suspect anything?’’; and ‘‘What were additional procedures that the
auditor performed to address this matter?’’ We noted that none of the partners indicated that they
had experienced significant difficulties in communicating KAMs to management and to those
charged with governance.
12. This result is consistent with the mean value (i.e., 7%) reported in Lang and Stice-Lawrence
(2015).
13. As expected, we find that the impacts of LOSS and EARNVOL on earnings response coefficients
(ERCs) are negative in the four models, all being significant at the 1% level. This indicates that
the market regards companies with lower profitability and higher earnings volatility as having
lower earnings quality. We also note that while not significant, the direction of the impact on
ERCs of SIZE, GRW, LEV, and BIG4 is consistent with our expectations and those of prior
studies.
14. Chinese Readability Index Explorer (CRIE 2.3), developed by National Taiwan Normal
University, is available at http://www.chinesereadability.net/crie/?LANG=CHT. The CRIE read-
ability measure is calculated as follows: the readability level (grade level) of the text = 4.53 +
0.01 3 [Difficult words] – 0.86 3 [Simple sentence ratio] – 1.45 3 [the logarithm of content
word frequency] + 0.02 3 [number of personal pronouns]. Studies have validated the effective-
ness of the CRIE system (e.g., Sung et al., 2013, 2015).
Chang et al. 19

15. Following Gutierrez et al. (2018) and Reid et al. (2019), we measure FEES as the natural loga-
rithm of audit fees and control for three additional variables (i.e., ARINV, GC, and NSEG; see
variable definitions in the appendix) in the audit fees models.

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