Tax Planning and Financial Expertise in the Audit Committee

Abstract

Specialized knowledge allows expert directors to provide valuable advice while simultaneously monitoring managers. We investigate the advising and monitoring roles of corporate directors by examining the relation between firm tax planning and the level of financial expertise on the audit committee. Consistent with the advising function, we find that firms whose audit committees have high levels of accounting expertise are associated with higher levels of tax planning. Consistent with the monitoring function, we find that firms with higher levels of accounting expertise on the audit committee are associated with a lower likelihood of engaging in risky tax planning. Despite controlling for CEO compensation, we find that the strength of corporate governance is associated with an overall reduction in both tax planning and risky tax planning. In contrast, we find evidence that firms with higher levels of non-accounting financial expertise on the audit committee exhibit a significantly higher likelihood of engaging in risky tax planning.