Do Auditor-Provided Tax Services Impair the Value Relevance of Earnings?

Abstract

Lately, several firms have decoupled audit and tax service providers to shore up the credibility of their financial statements. However, a number of other firms rely on the incumbent auditor for tax services. Do investors assign a lower valuation to firms that continue to use the auditor for tax services? We contribute to the literature by examining whether auditor-provided tax services moderate investor perception of earnings. We find that the value-relevance of earnings is increasing in the ratio of tax fees over total fees paid to the auditor. Further, for a sample of firms that switched to other providers of tax services, we find that the value-relevance of earnings is lower in the year of the switch. These findings support the notion that on average, investors perceive the benefits of auditor-provided tax services, i.e., enhanced financial reporting quality due to knowledge spillover to be greater than the likely threat to auditor independence caused by auditor-provided tax services. Our findings have important implications for audit committee chairs, managers, and regulators.

Keywords: Market valuation, Tax fees, Ohlson model, Knowledge spillover