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Audit committee disclosure tone and earnings management

This paper examines the effect of audit committee reporting, measured by the tone of audit committee disclosures, in improving financial reporting quality as proxied by earnings management. We focus on the textual properties of AC reports, particularly the tone of AC disclosure, and their impact on financial reporting quality proxied using real and accruals-based earnings management. For additional analysis, we use a financial reporting index and matched sample. Our analysis is based on a sample of UK FTSE 350 firms. Our analysis suggests that audit committee reports are not boilerplate but varied in language. We find audit committee reporting is negatively associated with both real and accruals-based earnings management. In our additional tests, we find a positive association between financial reporting quality index and reporting tone. Though the importance of AC disclosures in improving reporting quality is well recognised in policy guidelines and governance recommendations, no study has employed computer-based textual analysis of AC reports and investigated the effect of AC disclosure tone and the role it can play in achieving higher reporting quality. Overall, our paper provides baseline evidence for future research and policy making and reveals that ACs reporting what they have done increases transparency and impacts on reporting quality.