Spillover Effects of Clients’ Tax Enforcement on Financial Statement Auditors: Evidence from a Discontinuity Design

70 Pages Posted: 15 Nov 2019 Last revised: 20 Feb 2020

See all articles by Travis Chow

Travis Chow

The University of Hong Kong

Jeffrey Pittman

Memorial University ; Virginia Tech

Muzhi Wang

Central University of Finance and Economics (CUFE) - School of Accountancy

Le Zhao

Nankai University

Date Written: February 20, 2020

Abstract

We examine the impact of clients’ tax enforcement on financial statement auditors. In a regression discontinuity design, we exploit the firm-registration-date-based application of a new rule that assigns firms to two different tax enforcement regimes. Our analysis implies that auditors exert less effort–evident in lower audit fees and shorter audit report lags–when their clients are monitored by the more stringent tax authority. In results supporting that audit quality improves in this situation despite the fall in auditor effort, we report that clients subject to tougher tax enforcement exhibit a lower incidence of accounting restatements and tax-related restatements. Additionally, we find no evidence of impaired auditor independence evident in the informativeness of auditors’ modified opinions. Finally, we document that clients undergoing stricter tax enforcement are assigned less-experienced partners, suggesting that tax enforcement enables audit firms to optimize client-partner matching. Collectively, our research suggests that tax authority oversight engenders a positive externality by improving external audit efficiency.

Keywords: tax enforcement, audit fees, audit effort, auditor-client matching

JEL Classification: H25, H26, M42

Suggested Citation

Chow, Travis and Pittman, Jeffrey A. and Wang, Muzhi and Zhao, Le, Spillover Effects of Clients’ Tax Enforcement on Financial Statement Auditors: Evidence from a Discontinuity Design (February 20, 2020). Available at SSRN: https://ssrn.com/abstract=3487193 or http://dx.doi.org/10.2139/ssrn.3487193

Travis Chow (Contact Author)

The University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

Jeffrey A. Pittman

Memorial University ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

Virginia Tech ( email )

United States

Muzhi Wang

Central University of Finance and Economics (CUFE) - School of Accountancy ( email )

Beijing
China

Le Zhao

Nankai University ( email )

94 Weijin Road
Tianjin, 300071
China

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