Common institutional investors and the tone of key audit matters

Abstract

Common institutional investors have attracted considerable attention for their potential to collaborate and influence corporate governance, especially in relation to auditor behavior. Based on A-share listed companies from 2016 to 2022, this study examines the impact of common institutional investors on the tone of key audit matters (KAMs). Empirical findings show that these investors tend to push portfolio firms toward collusive fraud, prompting auditors to use a more negative tone in KAM disclosures. Moreover, major shareholders moderate the effect of common institutional investors on the tone of KAMs. Mechanism examinations reveal that common institutional investors increase a company's operational risks and reduce the comparability of its accounting information, prompting auditors to adopt a more negative tone in KAM disclosures. Heterogeneity analysis shows that the collusive fraud effect of common institutional investors is more significant in groups with low external competition, short-term institutional investors, and less developed regional markets. Furthermore, economic consequence analysis demonstrates that a negative KAM tone acts as an external monitoring tool and reduces the impact of common institutional investors on the risk of stock price crashes. This study complements the literature on the factors influencing KAM tone and the economic outcomes of common institutional investors' influence on auditor behavior. Furthermore, it has significant implications for companies to improve corporate governance and standardize market order.