Do External Auditors Respond to Tax Risk? Evidence from Audit Fees and Auditor-Provided Tax Services

• In Event: Auditor Assessment of Risk & Professional Skepticism

Abstract

Both practitioners and academics are increasingly focusing their attention on the riskiness of firms’ tax planning activities. In this study, we examine the association between tax risk—measured using the volatility of firms’ annual cash and GAAP effective tax rates—and external audit fees. 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 shown in prior research. We also find that knowledge spillover benefits associated with the provision of tax nonaudit services moderate this positive association. Broadly, 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.

Authors

• John L Abernathy, Kennesaw State University

• Eric T Rapley, Colorado State University

• James Stekelberg, University of Arizona-Tucson