The Form and Channels of the Association Between Effective Tax Rates and Audit Fees

We examine the form and channels of the association between effective tax rates (ETRs) and audit fees. We find that both low and high ETRs are positively related to audit fees, indicating a nonlinear (U-shaped) function. The results hold after controlling for ETR volatility, firm performance, ex-ante risk of misstatement, and internal control weaknesses. To better understand the role of taxes on audit pricing, we conduct interviews with audit and tax partners. The findings further support the idea that firms’ tax strategies affect audit fees. We then utilize path analysis and find evidence that tax volatility and employee competence serve as a mediating path between high ETRs and audit fees, whereas operating complexity, tax volatility, internal control weaknesses, and the presence of tax havens mediate the relation between low ETR and audit fees.