Mandatory audit partner's rotation and corporate tax avoidance: Early evidence from form AP disclosure

• Published date: 01 April 2021
• Author: Chenyong Liu,Chunhao Xu,Xiaohong (Sara) Wang
• Date: 01 April 2021
• DOI: http://doi.org/10.1002/jcaf.22489

Received:  November Accepted:  January 

DOI: ./jcaf.

BLIND PEER REVIEW

Mandatory audit partner’s rotation and corporate tax

avoidance: Early evidence from form AP disclosure

Chenyong Liu1Chunhao Xu2Xiaohong (Sara) Wang3

College of Business, TexasTech

University, Lubbock, Texas,USA

College of Business, University of Texas

of the Permian Basin, Odessa, Texas,USA

College of Business and Management,

Northeastern Illinois University, Chicago,

Illinois, USA

Correspondence

ChunhaoXu, Department of Accounting,

TheUniversity of Texas of the Permian

Basin, E. University, Odessa, TX

-,USA.

Email:xu_c@utpb.edu

Abstract

This study examines the impact of mandatory audit partner’s rotation on corpo-

rate tax avoidance. Using audit partners’ information disclosed in Form AP, we

find that companies generally increase their effective tax rates (ETRs) after audit

partner’s mandatory rotation, and the increase is specifically driven by compa-

nies hiring non-Big four auditors. This implies that incoming auditors, especially

those from non-Big four accounting firms, are more conservative in tax issues.

Further analysis suggests that companies engaging in less tax avoidance before

and simultaneously purchasing tax services from their auditors haveless increase

in ETRs after an audit partner’s rotation. The findings of this study assist both

audit practitioners and tax regulators to better understand the impact of audit

partner rotation on firm’s tax behaviors.

KEYWORDS

Audit partner mandatory rotation, Auditor-provided tax services, Corporate tax avoidance,

Form AP

1 INTRODUCTION

In the U.S., audit engagement partners in charge of listed

clients are mandated to rotate at least once every  years

since the s (Cameran et al., ). After , the

requirement of audit partner rotation becomes more strin-

gent from every  years to  years (Laurion et al., ).

Policymakers insist that mandatory audit partner’s rota-

tion can enhance auditor independence (Chi et al., )

as well as the overall audit quality (U.S. House of Repre-

sentatives, ). However, practitioners expressed their

concerns that the discontinuity of an audit partner’s work

would reduce audit quality since a new incoming partner

does not possess the equal knowledge and experience for

a certain client as the departing engagement partner does

(e.g., PricewaterhouseCoopers [PwC],  and ). Litt

et al. () also find that the financial reporting quality

in the first  years after an audit partner rotation is much

lower than that before the rotation. Because tax-related

accounts in financial statements are usually material in

audit engagements (Kanagaretnam et al., ), audit qual-

ity is correlated with tax risks. Aggressive tax avoidance

can increase audit risks, thus leading to higher audit fees

(Donohoe & Knechel, ;Hanlonetal.,). The enact-

ment of FIN  in  makes auditors’ responsibility in

auditing tax reporting items more salient (Erickson et al.,

). Although some extent studies have discussed the

impact of auditor rotation on audit quality (e.g., Bamber

&Bamber,; Daugherty et al., ;Littetal.,),

there is scant research about how audit partner’s manda-

tory rotation affects their clients’ tax behaviors. In this

study,we examine the impact of audit partner’s mandatory

rotation on corporate tax avoidancein the U.S.setting.

On one hand, with the concern that their clients using

tax reserves to manipulate earnings to meet or beat earn-

ings targets (Frank & Rego, ; Gleason & Mills, ),

Following Dyreng et al. () and Hanlon and Heitzman (), we

define tax avoidance as the actions taken by corporations to reduce

explicit taxes.

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