The effect of key audit matters on the association of credit risk and earnings quality

Abstract

Purpose

The purpose of this study is to examine whether the required disclosure and the high frequency of key audit matters (KAMs) are likely to moderate the effect of higher credit risk on earnings quality.

Design/methodology/approach

This study uses 15,106 Taiwanese firm-year observations to explore the relationship between earnings quality and credit risk during the 2011 to 2020 period. We use the two-stage least squares method to test whether the presence of KAM disclosures moderated the association between earnings quality and credit risk and also to examine whether higher KAM frequency moderates the association between earnings quality and credit risk.

Findings

Our results provide evidence that the presence of a KAM disclosure requirement moderates the impact of firms with higher credit risk on earnings quality. In addition, there is significant evidence that the higher the frequency of KAM disclosures the greater the moderation impact that is found.

Originality/value

This research investigates whether the disclosure and high frequency of KAMs moderates the effect of credit riskiness on earnings quality. This study improves our understanding of whether more KAMs disclosures would improve earnings quality of firms with higher credit risk. In addition, we also use Beneish M-SCORE, as an alternative earnings quality proxy, to reinforce our empirical results. This markedly differentiates this paper from other studies.

Citation

Chiang, S., Kleinman, G. and Lee, P. (2023), "The effect of key audit matters on the association of credit risk and earnings quality", Managerial Auditing Journal, Vol. 38 No. 7, pp. 997-1023. https://doi.org/10.1108/MAJ-02-2022-3465