Auditor fees, discretionary book-tax differences, and tax avoidance

Abstract

The European Commission (2014) aims to improve audit quality by prohibiting auditors from providing non-audit services, including tax advisory services that directly and significantly affect the company's financial statements. We investigate whether the audit quality and tax avoidance of German firms are affected by audit fees and/or tax fees. This study is the first to distinguish between the components of book-tax differences (BTDs) [i.e., normal and discretionary BTDs, and tax avoidance] while analysing the impact of auditor fees. We use discretionary BTDs attributable to discretionary accruals as a proxy for audit quality and hypothesise that audit fees are associated with audit quality, but not with a firm's tax avoidance. Furthermore, we propose that while tax fees affect tax avoidance, audit quality is not impacted. Our results show that audit fees affect only discretionary BTDs, while tax fees indeed only affect tax avoidance. Consistent with the argument of economic bonding, we find that the sum of non-audit fees lowers audit quality.