SUMMARY We examine whether external auditor behavior is sensitive to shifts in corporate tax enforcement. Using a regression discontinuity design that exploits a Chinese tax reform that assigns companies to two enforcement regimes based on registration dates, we find that auditors exert less effort—evident in lower audit fees—when clients are monitored by the more stringent tax authority, although their financial reporting quality improves, evident in a lower incidence of accounting and tax-related restatements. We also document that clients undergoing stricter tax enforcement have shorter audit report lags and are assigned less experienced partners. Collectively, the results are consistent with clients responding to tougher tax enforcement by improving compliance, which, in turn, reduces perceived audit risk and enables auditors to perform their work more efficiently. Surveys of auditors corroborate these inferences. Our evidence implies that tougher tax enforcement engenders a positive externality by improving audit efficiency without sacrificing reporting quality. Data Availability: The data used in this study are available from the sources cited in the manuscript. JEL Classifications: H25; H26; M42.
Chow et al. (Fri,) studied this question.