Political connection, audit quality, and tax avoidance

Abstract Crony capitalism and business‐politics nexus have been the focus of academic research and policy‐making in recent decades, particularly in developing countries where regulatory frameworks are evolving. This study investigates the relationship between political connections and tax avoidance, specifically examining the moderating role of audit quality in an emerging market. Using a curated dataset of firms listed on the National Stock Exchange of India from 2009 to 2022, we deploy multiple proxies for a firm's political connections to examine their association with the firm's tendency toward tax avoidance. Political connection is measured as total political connection, comprising both the promoter's channel and the donation channel. Tax avoidance is measured using cash effective tax rates, while audit quality is proxied through a composite index constructed from indicators such as engagement with Big Four audit firms, audit fees, and audit lag. The major findings of the study indicate that a firm with a political connection is more prone to engage in tax avoidance, consistent with rent‐seeking behavior. In terms of economic significance, a one‐standard‐deviation increase in political connection leads to a 1.96% increase in tax avoidance, thereby meaningfully reducing firms' effective tax payments. Importantly, higher audit quality mitigates this relationship, suggesting that stronger audit mechanisms can curb opportunistic tax behavior among politically connected firms. The study's findings are free of endogeneity bias, as assessed using two‐stage least squares and propensity score matching analyses. Furthermore, the results remain robust across generalized method of moment estimation, alternative proxies of political connection, tax avoidance, and audit quality, and across sub‐sample analysis. Cross‐sectional analysis further reveals that the influence of political connections on tax avoidance is stronger for business‐group‐affiliated firms but weaker in highly competitive industries.