We study the effects of the disclosure of critical audit matters (CAMs) on an auditor’s audit effort and an investor’s scrutiny effort decisions and on investment efficiency. Both the auditor and the investor can prevent a bad investment by respectively auditing and scrutinizing the firm’s financial reports to detect misstatements about the investment value. Investment efficiency is determined by the investor’s total mix of information. The disclosure of CAMs helps the investor assess investment risk and infer the auditor’s effort and thus enables the investor to fine-tune scrutiny effort, which can in turn adversely influence the auditor’s effort decision. We show when and why the disclosure of CAMs increases or decreases ex ante audit effort, ex ante investor scrutiny, and investment efficiency. Our analyses have both testable empirical implications and policy implications.
3917 8357
KK 1203
- BSocSc CUHK
- MA Western Ontario
- PhD British Columbia
Dr. Derek Chan obtained his Ph.D. in Business Administration (with a specialization in accounting) from the University of British Columbia in 1995. Prior to joining the Faculty of Business and Economics (now HKU Business School) of the University of Hong Kong in July 2001, he has served on the faculty of the School of Business & Management at the Hong Kong University of Science and Technology (HKUST) as an Assistant Professor in the Department of Accounting. He has also taught at the Beijing International MBA programme at Peking University. In 1999 and 2000, he was elected as a recipient of the Best Ten Lecturers Award. These awards are determined by student votes across all fields and departments at HKUST. Each year only ten awards are given for the entire university.
Dr. Chan’s research interests are primarily in the field of auditing, specifically on the industrial organization of audit markets and issues related to the regulation of professional accountants. His research has analyzed these issues both in general market settings, as well as in settings that reflect the realities of auditing environments. The research methodology that he has employed is analytical modelling. His research has been published in the leading academic journals in accounting. He has also frequently served as an ad hoc referee for research journals.
Dr. Chan is a member of the American Accounting Association and the Hong Kong Academic Accounting Association Limited.
- Intermediate Financial Accounting II
- Financial Statement Analysis and Business Ethical Standards (MFin)
- Industrial organisation of audit markets
- Equilibrium models of regulation of professional accountants
- Financial reporting
- Disclosure theory
- Information economics
- Chan, D., and N. Liu, “The Effects of Critical Audit Matter Disclosure on Audit Effort, Investor Scrutiny, and Investment Efficiency”, The Accounting Review, forthcoming.
- Chan, D., and N. Liu, “Financial Reporting, Auditing, Analyst Scrutiny, and Investment Efficiency”, The Accounting Review, Vol. 97, No.5, pp. 163-188.
- Chan, D., X. Li, and Q. Xin, 2021, “Institutional Investor Inattention and Audit Quality”, Journal of Accounting and Public Policy, Vol. 40, No. 3, Article 106857.
- Chan, D., and J. Gao, 2014, “Earnings Management, Incentive Contracts and Private Information Acquisition”, Journal of Accounting and Public Policy, Vol. 33, No. 6, pp. 529-550 (Lead Article).
- Liu, X., and D. Chan, 2012, “Consulting Revenue Sharing, Auditor Effort and Independence, and the Regulation of Auditor Compensation”, Journal of Accounting and Public Policy, Vol. 31, No. 2, pp. 139-160 (Lead Article).
- Chan, D., and K. P. Wong, 2002, “Scope of Auditors’ Liability, Audit Quality, and Capital Investment”, Review of Accounting Studies, Vol. 7, No. 1, pp. 97-122.
- Chan, D., 1999, “Low-Balling and Efficiency in a Two-Period Specialization Model of Auditing Competition”, Contemporary Accounting Research, Vol. 16, No. 4, pp. 609–642.
- Chan, D., and K. P. Wong, 1999, “CVP under Uncertainty and the Manager’s Utility Function Revisited”, Review of Quantitative Finance and Accounting, Vol. 12, No. 2, pp. 159-171.
- Chan, D., and S. Pae, 1998, “An Analysis of the Economic Consequences of the Proportionate Liability Rule”, Contemporary Accounting Research, Vol. 15, No. 4, pp. 457-480.
- Wong, K. P., and D. Chan, 1993, “A Simple Model of Spatial Banking Competition”, Economic Letters, Vol. 42, No. 4, pp. 391-397.
- University of British Columbia: Accounting Development Fund Graduate Fellowship, 1991-93;
- University Graduate Fellowship, 1993-95
- Contemporary Accounting Research Forum Fellow, 1991
- American Accounting Association Doctoral Consortium Fellow, 1993
- Best Ten Lecturers Award, 1998-99 & 1999-2000
- Member of the Users’ Committee of the HKSAR Inland Revenue Department
- Academic advisor of the Hong Kong Institute of Chartered Secretaries (HKICS)
- QP mentor for the Hong Kong Institute of Certified Public Accountants (HKICPA)
This paper presents an economic framework to study strategic interactions along the analyst-auditor-owner disciplinary chain, in which the auditor examines the financial reports prepared by the owner, and the analyst uncovers financial misreporting as well as audit failure. We find that although analyst scrutiny ex post detects misreporting, it ex ante aggravates the owner's misreporting behavior and further impairs financial statement reliability if the legal penalties for the auditor and the owner are small. We also show how the effects of a regulation depend on its target's disciplinarian(s). Specifically, (i) although enhancing the auditor's legal liability always increases audit quality and financial statement reliability, it decreases investment efficiency if and only if the analyst is highly independent; and (ii) increasing the owner's misreporting penalty decreases investment efficiency if and only if either of (but not both) the regulations on the auditor and the analyst is strict.