Voluntary Disclosure of Auditor-Provided Tax Service Fees

Abstract

This study examines the decisions of firms to voluntarily disclose tax fees paid to their external auditors. Although the Securities and Exchange Commission (SEC) began requiring public companies to disclose fees paid to auditors in 2000, separate disclosure of tax service fees as a component of those fees was not required until 2003. During this period there was increased scrutiny by the SEC on many aspects of the auditor-client relationship, and by the Internal Revenue Service (IRS) on the sale of tax shelters by large public accounting firms to their clients. Hence, we predict that the decisions of firms buying tax services from their auditor to voluntarily disclose fees for those services will be significantly influenced by political costs associated with heightened regulatory scrutiny. Results show that the likelihood of separate disclosure of tax fees in 2002 is negatively associated with the ratio of nonaudit service fees (NAS) to total fees, thus supporting the political cost hypothesis. Importantly, we find that the negative association of political cost and disclosure is exacerbated by both audit committee governance and audit firm size. We also find the disclosure decision to be positively associated with agency costs (institutional ownership and size), and negatively associated with the relative amount of deferred taxes, firm profitability, and auditor change. In summary, these results shed light on the roles played by two important players in the corporate governance structure of a firm (the audit committee and the audit firm) in determining a firm's voluntary disclosure practices.

Keywords: Nonaudit services, tax consulting, voluntary disclosure, political costs

JEL Classification: H25, M40, M41, M49