PCAOB Inspections, Knowledge Diffusion, and Corporate Tax Planning Effectiveness

• In Event: Doctoral Student Faculty Interchange I

Abstract

This study examines the impact of auditors’ exposure to PCAOB inspection on their clients’ tax planning effectiveness. Improving the reliability of reported income tax amounts has been a focus of the PCAOB since its inception, and PCAOB inspections commonly scrutinize the auditing of income taxes. We posit that auditors increased their tax-related knowledge in response to the onset of PCAOB inspections and that this knowledge diffused to their clients. We find evidence consistent with this expectation and estimate that a client’s tax planning effectiveness increased by 4.5 percent on average following their auditor’s initial exposure to PCAOB inspection. This result is stronger among auditors without tax-related PCAOB inspection deficiencies, auditors with less pre-PCAOB tax planning expertise, and clients with greater tax planning incentives. We also show that auditors’ exposure to PCAOB inspection led to affected clients increasing their income shifting activities, which suggests a plausible mechanism for our main results. Our study suggests that the initiation of PCAOB inspections increased auditors’ tax-related knowledge and that this knowledge diffused to auditors’ clients as evidenced by more effective tax planning decisions.

Authors

• Tyler Kleppe, University of Kentucky

• James Justin Blann, University of Arkansas

• Nathan Chad Goldman, North Carolina State University