Do Critical Audit Matters (CAMs) Provide a Road Map for Litigation? Evidence from Revenue CAMs

PCAOB AS 3101 requires the auditor to communicate in the audit report any critical audit matters (CAMs) identified during the planning or performance of the audit. One of the most common type of CAMs (revenue CAMs) relates to core earnings, which is fundamental to valuing a corporation (Penman 2001; Bradshaw and Sloan 2002). We examine whether attorneys use revenue CAMs to identify litigation targets when there is a drop in the stock price. We demonstrate that companies with revenue CAMs are more likely to be sued than companies without revenue CAMs when there is a drop in the stock price. Further analysis shows that attorneys specifically focus on revenue CAMs when there is a decrease in sales from the prior year or when there are higher levels of discretionary revenues. Our results highlight an unintended consequence associated with the recent change in the PCAOB audit report