Disclosure of key audit matters and market reaction: the case of companies listed on the Nairobi Securities Exchange

Kithinji, Freda Mwendwa
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Strathmore University
This study was aimed at investigating whether the disclosure of key audit matters in the auditor’s report of listed companies in the Nairobi Securities Exchange causes a reaction in the stock market. The purpose of this was to establish the information value and hence the usefulness of key audit matters information for the benefit of investors and the Nairobi Securities Exchange market in general. A descriptive research design and quantitative methods were adopted for this study. Secondary data comprising key audit matters as the independent variable was collected from annual reports of companies listed in the Nairobi Securities Exchange, while cumulative average abnormal returns were derived as the dependent variable from listed company stock prices obtained from the NSE. The research focused on four key audit matters namely impairment of assets, valuation of financial instruments, revenue recognition and tax liabilities, for the first three years after implementation of the KAMs regulation effective December 2016, globally. Cumulative average abnormal returns were used as a measure of the stock market reaction. Control variables including company size, audit firm size, earnings per share, debt ratio and return on assets collected from NSE listed company annual reports, were added to the analysis to evaluate their effect on the independent and dependent variables. Event study methodology was applied with the date of release of the audit report with KAMs being the event date over an event window of 30 days before and after event date. Findings from the regression analysis performed using SPSS revealed a significant relationship between all KAMs studied and cumulative average abnormal returns at 95% confidence interval, hence KAMs elicit a stock market reaction at the NSE. Additionally, the KAMs led to an increase in abnormal returns in the first year they were implemented, followed by a decrease in abnormal returns in the following two years indicating that overtime there was a possible reduction in information relevance of the KAM which requires attention by the audit regulator, ICPAK to explore ways of improving on the KAMs disclosure. When control variables were added to the regression model, return on assets ratio was most impactful compared to the KAM, meaning that investors still consider company financials as important in the presence of KAMs. KAMs are a significant predictor on their own. The limitations of this study included using AGM date as event date proxy; the study was limited to analysing the market reaction to four specified KAM topics and focused on the presence and not extremity of the KAM disclosure which have been recommended as areas for further research. From the findings of this study, the researcher recommends a consideration into adoption of KAMs regulation by government and other regulatory agencies such as the Office of the Auditor General, the Central Bank of Kenya and the Retirement Benefits Authority for their respective auditees and licensees, for the benefit of their stakeholders given the information value from KAMs, for better transparency.
A Thesis submitted in partial fulfillment of the requirements for the award of the Degree of Masters of Business Administration at Strathmore University Business School
Audit/auditor’s report, Investors, Key audit matters, Stock market, Stock market reaction