Audit Committee Financial Expertise, Litigation Risk, and Auditor-Provided Tax Services

Abstract

The Sarbanes-Oxley Act greatly expanded audit committees’ oversight responsibilities by requiring that they preapprove all non-prohibited non-audit services (NAS). Using data from 2003 to 2011, we find that tax NAS are significantly lower when accounting financial experts (ACT-FEs) serve on the audit committee, suggesting that ACT-FEs consider auditor independence risk, perceived and/or real, more than other members, including supervisory experts, to the point of not accepting any tax NAS, not even compliance. However, in firms with higher ex-ante litigation risk, ACT-FEs approve relatively more tax NAS than other members, suggesting that they accept the costs of a perceived lack of auditor independence from tax NAS in return for the potential benefits of increased financial reporting quality arising from tax NAS. Our analysis by sub-period (2003 to 2006 versus 2007 to 2011) shows that this result is significant only in the second period. ACT-FEs’ differential evaluation of the trade-off between the benefits and costs of joint audit and tax NAS provision between the two periods suggests the need for additional research in later post SOX years.

Keywords: Auditor-provided tax services, non-audit services, auditor independence, audit committee, financial expertise, litigation risk

JEL Classification: G38, H25, K22, M40, M41