Corporate risk disclosure and key audit matters: the egocentric theory

• DOI: https://doi.org/10.1108/IJAIM-10-2021-0213
• Published date: 15 March 2022
• Date: 15 March 2022
• Pages: 230-251
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Mahmoud Elmarzouky,Khaled Hussainey,Tarek Abdelfattah,Atm Enayet Karim

Corporate risk disclosure and

key audit matters: the

egocentric theory

Mahmoud Elmarzouky

Kingston Business School, Kingston University, London, UK

Khaled Hussainey

Faculty of Business and Law, University of Portsmouth, Portsmouth, UK

Tarek Abdelfattah

Faculty of Business and Law, University of Portsmouth, UK and

Faculty of Commerce, Mansoura University, Egypt, and

Atm Enayet Karim

Department of Accounting and Financial Management, Global Banking School,

Birmingham, UK

Abstract

Purpose –This paper aims to provide unique interdisciplinary research evidence between the risk

information disclosedby auditors and the risk information disclosed by corporatemanagers. In particular, it

investigates the association between the level of risk information disclosed by auditors (key audit matters

[KAMs]) and the levelof corporate narrative risk disclosure.

Design/methodology/approach –The study sample consists of the UK FTSE all-share non-f‌inancial

f‌irms across six f‌inancialyears. The authors use a computer-aided textual analysis, and the authors use a bag

of words to scorethe sample annual reports.

Findings –The results suggest that KAMsand corporate narrative risk disclosure levels vary across the

industries. The authors found a signif‌icant positive association between the risk information disclosed by

auditors and the risk information disclosed by corporate managers. Also, the authorsfound that FTSE 100

f‌irms exhibithigher signif‌icance between the ongoing concern and the level of narrative risk disclosure.

Practical implications –The study approach helps assess the level of management risk reporting

behaviour due to the new auditor risk reporting standards. This helpsto emphasise how auditors and companies

engage and communicate risk-related information to stakeholders. Standard setters should suggest a more

detailed reporting framework to protect the shareholders. The unique f‌indings are incredibly benef‌icial to the

regulators, standard setters, investors, creditors, suppliers, customers, decision makers and academics.

Originality/value –This paper provides a shred of extraordinary evidence of the impact of auditorrisk

reporting and management risk reporting. To the best of the authors’knowledge, no study has yet

investigatedthe corporate narrative disclosure after the new audit standardsISA 700 and ISA 701.

Keywords Key audit matters, Risk disclosure, Textual analysis, UK

Paper type Research paper

1. Introduction

Because of the f‌inancial crisis, in early 2011, the Financial Reporting Council (FRC) introduced

some suggestions in its Consultation Paper “Effective Company Stewardship-Enhancing

Corporate Reporting and Audit (FRC, 2011)”. The paper recommended changes needed to the

IJAIM

30,2

230

Received19 October 2021

Revised18 January 2022

Accepted3 February 2022

InternationalJournal of

Accounting& Information

Management

Vol.30 No. 2, 2022

pp. 230-251

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-10-2021-0213

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

auditing standards. In response to the belief that the audit reporting needs improvement, several

phases of global approaches have been in place to change the independent audit report’sstyleand

contents (Sierra-García et al., 2019). In 2013, the UK became the f‌irst country to introduce(ISA 700

UK and Ireland) expanded audit reports (Hogan et al.,2015).The f‌irst reports are r equired for the

September 2013 year-ends. Also, in June 2016, the UK was the f‌irst country to adopt ISA 701 (key

audit matters [KAMs]). The IAASB def‌inesKAMsintheISA701as:“Those matters that, in the

auditor’s professional judgment, were of most signif‌icancein the audit of the f‌inancial statements

of the current period”.

Narrative reporting has been the management’s most common communication channel

with the stakeholders (Elmarzouky et al., 2021;Boura et al.,2020;Fisher et al.,2019). The

central bank of England in 2017 reported that around 90% of the f‌inancial informationwas

extracted from the narrativesections rather than the f‌inancial statements (Bank of England,

2015;Lewis and Young, 2019). According to Srinivasan (2018), it is more benef‌icial to

analyse the narrative sections on the annual reports than to focus only on the f‌inancial

statements or the quantitative data provided by the management (Karim et al., 2021;

Moroney et al.,2021). Beattie et al. (2004) highlighted that it is hard to quantify all the

management’s information to deliver to the stakeholders. There is also an increase in the

volume of narrative disclosure. Fisheret al. (2019) estimated that between 80% and 90% of

all business information might originate in narrative form by 2020. Therefore, textual

analysis became increasingly important in accounting, auditing and f‌inance research

(Loughran and McDonald,2016;Fisher et al.,2019).

Egocentric bias theory suggests managers will always have the ego to control the

stakeholder’s decision (Grossman, L. 2018); therefore, they will disclose a higher volume of

information than the external auditors. We expect this will increase the level of voluntary

risk disclosure by corporatemanagers.

So, the question arises whether disclosing more KAMs by the auditors will increase the

level of narrative risk disclosureby corporate managers. Therefore, we investigatehow risk

disclosure behaviourby the auditor will impact management disclosure practicebehaviour.

We are motivated by the global phenomenonthat attracted the attention of policymakers

and academics after the outburst of the f‌inancialcrisis and corporate scandal. Also, the need

from stakeholders for new auditing regulations to increase the level of information and

transparency. Given that, the academic research far from conclusive whether this new

regulation has achieved the target from it. And with no standardised templates for KAMs,

the impact of KAMs is empiricallyunclear.

This paper has several contributions. First: we have a unique theoretical contribution by

applying a psychological theory (the egocentric theory) in accounting research. The egocentric

theory suggests that humans will always have the f‌inal impact on others. So, managers will ever

care to drive the stakeholders’decisions (Krause and Tse, 2015). Our f‌inding supports the theory’s

claim. The increase of KAMs will pressure the management to disclose more information

themselves. Second: we contribute to disclosure and auditing literature by f‌illing an important

research gap. The link between auditor disclosure and management disclosure is yet to be

researched; our paper is the f‌irst to contribute to this gap in the literature. Third: we provide

empirical evidence on how the management risk discourse reacts to the ISA 701 KAMs. We also

show that the level of the relationship between the KAMs and the management risk disclosure

varies with different market capitalisation.

2. Literature review and hypotheses development

On 15 December 2016, the ISA 701 came into force in the UK, which changed the

independent auditor’s focus to a risk-based audit approach. The ISA 701 communicating

Corporate risk

disclosure

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