Mandatory disclosure of key audit matters and the choice of earnings management

Abstract

This paper examines client managers' earnings management choices following the adoption of mandatory reporting on key audit matters in the UK. Using a difference‐in‐differences design, we find that managers engage less in accrual‐based earnings management and more in real earnings management after the introduction of key audit matter (KAM) reporting. With textual data, we show that the disclosure characteristics (such as specificity, similarity, readability and length) and types of KAMs also affect the choice of earnings management. The decrease in accrual‐based earnings management is eclipsed by the increase in real earnings management; thus, total earnings management does not change significantly.