Mandatorily Disclosed Materiality Thresholds, their Determinants, and their Association with Earnings Multiples

This study addresses two related research questions concerning a new requirement in the United Kingdom that auditors disclose the materiality thresholds they apply when conducting the audit of listed companies. First, are cross-sectional differences in materiality thresholds associated with differences in the demands of financial statement users for high quality information as reflected by differences in analyst following, leverage, and managerial equity stakes? We find that the firm's reliance on debt financing and the extent of insider shareholding are associated with lower auditor materiality thresholds. Second, do investors use the materiality threshold information when assessing the reliability of earnings for equity valuation purposes? We find that the difference between the earnings multiples of high and low materiality firms decreases after the disclosure of the thresholds. This finding is consistent with low materiality firms benefiting from the revelation that auditors apply a more stringent threshold, thereby improving the perceived relative reliability of their financial statements