External Auditor Responses to Tax Risk
Journal of Accounting, Auditing and Finance, Forthcoming
Posted: 27 Oct 2016 Last revised: 11 Sep 2019
Date Written: September 10, 2019
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: Suggested Citation