Does Auditor Litigation Risk Constrain Corporate Tax Avoidance? Evidence from a Quasi-Natural Experiment

We examine the effect of auditors’ litigation risk on corporate tax avoidance following pivotal US court rulings. Our findings indicate a significant association between increased litigation risk and reduced tax avoidance that persists even after controlling for other influencing factors. A focused analysis of New Jersey and California with lower auditor litigation risks reveals higher levels of tax avoidance. This effect is more pronounced among financially constrained companies, firms with higher litigation risk, and firms that previously engaged in significant tax avoidance, particularly when audited by Big N auditors. This research addresses the call for more insight into the benefits of increased auditor litigation risk, shedding light on the complex interplay between auditor behavior and tax avoidance. It also informs the ongoing discussions on whether expanding auditor liability to third-party claims can enhance audit quality.