Do Auditors Respond to Corporate Tax Enforcement? Evidence from Earnings Management Through Tax Expenses

46 Pages Posted: 26 Apr 2024

See all articles by Kenny Lin

Kenny Lin

Lingnan University

Zhenyang Shi

BI Norwegian Business School

Fang Zhang

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law

Abstract

Motivated by the limited research on the interplay between statutory and tax auditors, this study examines whether the former respond to tax expense management when their clients face heightened tax enforcement in China. The findings reveal that in the presence of stricter tax enforcement, large auditors are more likely than their small counterparts to disapprove of their clients’ attempts to manipulate earnings through tax expense reduction. This result suggests that higher-quality auditors behave more conservatively to avoid regulatory and reputation costs caused by tax income restatements and government sanctions. Moreover, this study finds that auditor conservatism is more pronounced when client firms have prior experience with tax restatement and penalty, as well as when signatory auditors bear higher political risk. This study expands the boundaries of prior studies that examine the separate roles of statutory and tax auditors in the financial reporting process and provides new insight into the interaction between the two monitors of management actions. Our findings highlight that the tax authority, as a significant public governance body, contributes to enhancing the complementarity of audit and tax enforcement, jointly improving firms’ financial disclosure quality.

Keywords: Audit quality, effective tax rate, reporting incentives, tax enforcement, large auditors.

Suggested Citation

Lin, Kenny and Shi, Zhenyang and Zhang, Fang, Do Auditors Respond to Corporate Tax Enforcement? Evidence from Earnings Management Through Tax Expenses. Available at SSRN: https://ssrn.com/abstract=4808296 or http://dx.doi.org/10.2139/ssrn.4808296

Kenny Lin

Lingnan University ( email )

Hong Kong
China

Zhenyang Shi (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Fang Zhang

Hong Kong Baptist University (HKBU) - Department of Accountancy & Law ( email )

Kowloon Tong, Kowloon
Hong Kong

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