Accounting Working Papers

Audit firms are restricted from provided most nonaudit services to their public company audit clients, A notable exception is tax consulting services. We examine whether tax consulting services are associated with the likelihood of tax-related and other material weaknesses in internal control. The extent of tax consulting measured by the ratio of tax fees to total fees is associated with a significantly lower likelihood of a tax-related internal control weaknesses, but an indicator variable for the presence of tax consulting is not. The tax fee ratio is also associated with a reduced likelihood of other types of internal control weaknesses. These results are consistent with auditor-provided tax services reducing independence, rather than knowledge spillovers arising from the provision of tax services.

Audit firms are restricted from provided most nonaudit services to their public company audit clients, A notable exception is tax consulting services. We examine whether tax consulting services are associated with the likelihood of tax-related and other material weaknesses in internal control. The extent of tax consulting measured by the ratio of tax fees to total fees is associated with a significantly lower likelihood of a tax-related internal control weaknesses, but an indicator variable for the presence of tax consulting is not. The tax fee ratio is also associated with a reduced likelihood of other types of internal control weaknesses. These results are consistent with auditor-provided tax services reducing independence, rather than knowledge spillovers arising from the provision of tax services.

This paper examines how banks impound implicit taxes into loan interest rates. Economic theory predicts that the most flexible party bears the least tax cost. We hypothesize that mortgagors, being geographically fixed, are less flexible than banks and bear greater implicit tax costs, and that this effect diminishes when, after the 1994 Riegle-Neal Interstate and Branching Efficiency Act, banks competed across state lines. Using data from 1977 to 2004 on banks' and mortgagors' state and federal taxes and detailed loan-specific data on mortgage originations, we investigate how interest rates vary separately with banks' and mortgagors' taxes. We find that mortgage rates vary positively with both banks' and the value of mortgagors' interest tax deductions. These findings are consistent with banks both passing on their tax costs to borrowers and capturing portions of borrowers' tax benefits. The estimated annual magnitude of this tax shift is $21.7 billion, which we find declined after 1993 by approximately 40 percent.

Utilizing the well-established economic theory of customer switching cost competition we examine the relation between audit competition and auditor independence as reflected in the quality of publicly-traded firms' financial statements. We examine this question in the time period from 1975-2005, a period said to be one of great change in the independence of the audit profession and one in which its competitiveness increased substantially. Measuring audit competition with the annual rate of audit turnovers, as substantially supported by economic research, and financial statement quality with the level of discretionary accruals, as substantially supported by accounting research, we find that as audit competition increased, financial statement quality declined. The enactment of Sarbanes-Oxley is found to have significantly reduced this effect consistent with the intent behind the passage of this law, though its effect seems concentrated predominantly in 2002, the year of its passage.