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Auditor-provided Tax Services and ‘Last-chance’ Earnings Management: The Importance of Audit Committees
Ling Lei,
University of Connecticut
ABSTRACT. At present, regulators do not prohibit auditors from providing tax services to their public audit clients, provided that these services are pre-approved by clients’ audit committees. However, the Public Company Accounting Oversight Board remains concerned that these services might impair auditor independence. This paper examines the association between auditor-provided tax services and ‘last-chance’ earnings management (i.e., earnings management in tax expense to avoid missing analyst forecasts), with a particular focus on whether this association varies with audit committee effectiveness. I develop a composite proxy for audit committee effectiveness by combining three characteristics: committee size, meeting frequency, and the proportion of members with accounting experience. I find that auditor-provided tax services are associated with less ‘last-chance’ earnings management when audit committees are more effective, while the association is insignificant when audit committees are less effective.
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