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

Abstract

Recently, some firms have decoupled their audit and tax service providers in an effort to improve the perceived credibility of their financial statements. Many firms, however, continue to rely on their current auditor for tax services. Therefore, we examine whether investors assign a lower valuation to firms that continue to use their auditor for tax services. 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 costs of auditor- provided tax services, i.e., threat to auditor independence. Our findings have important implications for audit committee chairs, managers, and regulators.

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