External Auditor Responses to Tax Risk

Journal of Accounting, Auditing and Finance, Forthcoming

Posted: 27 Oct 2016 Last revised: 11 Sep 2019

See all articles by John L. Abernathy

John L. Abernathy

Kennesaw State University

Andrew Finley

Claremont McKenna College - Robert Day School of Economics and Finance

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting

James Stekelberg

Colorado State University, Fort Collins - Department of Accounting

Date Written: September 10, 2019

Abstract

Both practitioners and academics are increasingly focusing their attention on the riskiness of firms’ tax planning activities. In this study, we examine how external auditors respond to tax risk, measured using the volatility of firms’ annual cash and GAAP effective tax rates. Consistent with the notion that tax risk represents a source of engagement risk that is priced by external auditors, we first document a positive association between audit fees and tax risk incremental to fee premiums arising from tax aggressiveness. We also find that knowledge spillover benefits related to the provision of tax nonaudit services moderate this positive association. In supplemental tests, we provide evidence on additional auditor responses to tax risk. In particular, we document that tax risk is positively associated with both audit report lag and the likelihood of the auditor reporting a tax-related material weakness in the client's internal controls. Our findings add to the growing literature at the intersection of corporate taxation and auditing, and to the literature distinguishing between the level and riskiness of firms’ tax avoidance strategies.

Keywords: Audit Fees, Tax Risk, Effective Tax Rates, Auditor-Provided Tax Services, Nonaudit Services

JEL Classification: H25, M40, M41, M42

Suggested Citation

Abernathy, John L. and Finley, Andrew and Rapley, Eric T. and Stekelberg, James, External Auditor Responses to Tax Risk (September 10, 2019). Journal of Accounting, Auditing and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2859140 or http://dx.doi.org/10.2139/ssrn.2859140

John L. Abernathy

Kennesaw State University ( email )

1000 Chastain Road
Kennesaw, GA 30144
United States

Andrew Finley

Claremont McKenna College - Robert Day School of Economics and Finance ( email )

500 E. Ninth St.
Claremont, CA 91711-6420
United States

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting ( email )

257 Rockwell Hall
Fort Collins, CO 80523
United States
970.491.7481 (Phone)

James Stekelberg (Contact Author)

Colorado State University, Fort Collins - Department of Accounting ( email )

256 Rockwell Hall
Fort Collins, CO 80523
United States

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