Statutory Auditors and Tax Compliance: Evidence from a Quasi-Natural Experiment

Abstract

The research problem We evaluated the effectiveness of statutory auditors as a tax inspection mechanism and examine a regulation change that occurred in Greece. In 2011, the Greek State passed a directive requiring that statutory auditors audit and certify the tax compliance of medium and large firms, and issue a Tax Compliance Report (TCR). Motivation The evidence on the auditors’ effect on tax avoidance is quite limited. Our research setting constitutes a unique quasi-natural experiment to evaluate auditors’ effectiveness and firms’ tax avoidance behavior under a new tax compliance regime. The test hypothesis We tested the following hypothesis: Tax avoidance was significantly reduced in the post-TCR period for firms subject to TCR. Target population Our target population consisted of firms that are subject to audits from statutory auditors for tax compliance purposes. Adopted methodology We employed a difference-in-differences design with Greek firms subject to TCR as the treated group and the rest of the Greek firms as the control group. We examined potential differences from the TCR enforcement for the two groups. Analysis Our main analysis presents results for the treated and the control groups regarding their non-conforming and conforming tax avoidance behavior in the pre- and the post-TCR period. Non-conforming refers to activities that reduce taxable income but leave book income unaffected, whereas conforming tax avoidance refers to activities that reduce both taxable income and book income. Additional analysis evaluates the effect of Big 4 audit firms, increased audit effort, and assignment of the TCR to the financial statements’ auditor. Findings Our empirical results suggest that non-conforming tax avoidance for treated firms (i.e., firms subject to tax audits) significantly decreased in the post-TCR period compared with that of the control sample (i.e., firms not subject to tax audits). Conversely, conforming tax avoidance increased. This evidence suggests that treated firms switched from non-conforming to conforming tax avoidance activities. Our results hold irrespective of the size of the audit firm that performed the TCR program, but we find that increased audit effort to accomplish the TCR program and the assignment of the TCR to the auditor who also audited the financial statements had an incremental impact on the reduction of non-conforming tax avoidance.