Corporate Tax Aggressiveness, Auditor Provided Tax Services, And Audit Quality: Evidence From Recent PCOAB Rules Concerning Independence And Tax Services

Using tax accrual quality as a proxy for audit quality, I investigate whether
companies that significantly decreased APTS surrounding the effective date of the Public
Company Accounting Oversight Board’s 2006 Rules on Ethics, Independence, and Tax
Services experienced an improvement in audit quality after the change. Given the
specific target of the PCAOB 2006 restrictions is companies aggressively avoiding taxes
with the assistance of APTS, I also investigate whether companies associated with tax
aggressive services are also more likely to experience an improvement in audit quality
following the reductions in APTS.
Results suggest an increase in audit quality due to a reduction in economic
bonding following APTS restrictions. Consistent with the economic bonding theory,
companies that significantly reduced APTS experienced a larger improvement in audit
quality after the change compared to companies that did not significantly reduce APTS. For tax aggressive companies, those that reduced APTS did experience a
significant increase in audit quality after the change compared to tax aggressive
companies that did not significantly reduce APTS. Moreover, companies considered
important tax clients by their audit firms that significantly reduced APTS did experience
a marginally greater increase in audit quality after the change compared to other
important tax clients that did not significantly reduce APTS.
Overall, my results indicate that the PCOAB 2006 restrictions were effective in
decreasing APTS and economic bonding, thereby leading to improved audit quality,
especially among companies associated with tax aggressive services. Accordingly,
concerns for loss of knowledge spillover seem to be minimal. There are few studies that
investigate the effectiveness of the PCAOB 2006 restrictions on audit quality. Therefore,
my study fills this void by using a tax specific measure of audit quality, tax accrual
quality, to specifically examine the target of the restrictions— audit clients that are
associated with aggressive tax services. My study confirms and expands APTS,
economic bonding, audit quality, tax accrual quality, and tax aggressive research, and
also provides insight into and support for current policy debates concerning APTS and
tax aggressive services.