Do Complexity, Governance, and Auditor Independence Influence Whether Firms Retain Their Auditors for Tax Services?

Abstract

This study examines factors that influenced public companies to retain or dismiss their audit firms as tax service providers during the years immediately surrounding the passage of the Sarbanes-Oxley Act (SOX) in 2002. We find a positive relation between a company’s tax and operating complexity and the probability that it retained its auditor-provided tax services, suggesting that complexity increases the potential benefits from knowledge spillover relative to the costs from perceived auditor independence impairment. We find a positive relation between the strength of a company’s corporate governance and the probability that it would retain auditor-provided tax services, suggesting that companies with strong governance expected benefits from knowledge spillover to exceed costs from perceived auditor independence impairment. Although we find no direct relation between auditor tenure and the decision to retain auditor-provided tax services, we do find a significant negative association between auditor retention and high non-tax NAS fees and between auditor retention and the joint effect of long auditor tenure and high non-tax NAS fees. Thus firms with low auditor independence and long audit tenure are less likely to retain their auditor for tax services than firms with high non-tax NAS fees alone.

Keywords: governance, auditor independence, tax services, complexity, nonaudit services

JEL Classification: H25, M40, M41, M49