Screenplays & Play

Competition for Non-Audit Services among Professional Services Firms: Determinants

Description
Competition for Non-Audit Services among Professional Services Firms: Determinants and Consequences of Tax Service Provider Choice in the Not-for-Profit Sector Stevanie S. Neuman Ph.D. Student Mays Business
Published
of 25
All materials on our website are shared by users. If you have any questions about copyright issues, please report us to resolve them. We are always happy to assist you.
Related Documents
Share
Transcript
Competition for Non-Audit Services among Professional Services Firms: Determinants and Consequences of Tax Service Provider Choice in the Not-for-Profit Sector Stevanie S. Neuman Ph.D. Student Mays Business School Texas A&M University Thomas C. Omer Professor of Accounting Mays Business School Texas A&M University Anne M. Thompson Assistant Professor College of Business The University of Illinois Abstract: This study examines the determinants and consequences of tax service provider choice among not-for-profit organizations. This question is important for understanding how public accounting firms compete for tax and non-audit service revenues and for understanding variation in firms tax reporting and avoidance behavior. Because public accounting firms compete with law and consulting firms for tax clients, we draw upon the organizational studies literature to examine whether factors that influence the organizational structure of professions - proximity to clients and knowledge availability - influence clients decisions to purchase tax services. Using data from the U.S. not-for-profit (NFP) sector where the decision to purchase tax services is observable for all organizations, we find that NFP organizations are less likely to retain their auditor for tax services as the availability of local tax knowledge increases and distance to the auditor increases. In addition, Big N audit clients are more likely to choose a law or consulting firm for tax services, or to self-prepare the tax return. We find that NFPs that selfprepare the tax return receive lower contributions from the public, suggesting that donors attach lower credibility to self-prepared returns. Finally, our NFP results generalize to public companies, as SEC registered firms are less likely to retain their auditor for tax services as distance to the auditor increases and the availability of knowledgeable professionals increases. Data availability: Data are available from the sources indicated in the text. Acknowledgements: This project was funded by a grant from the Mays Business School at Texas A&M University. We thank Michael Mayberry and Jaron Wilde for their helpful comments. Professor Omer acknowledges funding provided by Ernst and Young. Competition for Non-Audit Services among Professional Services Firms: Determinants and Consequences of Tax Service Provider Choice in the Not-for-Profit Sector I. INTRODUCTION Tax services, like other non-audit services performed by public accounting firms, do not fall within the exclusive licensing jurisdiction of public accountants. Law and consulting firms also provide tax services and prospective clients may, instead, choose to self-prepare or invest in internal tax resources. Although public companies disclose tax and other non-audit service fees paid to their financial statement auditor in independence related disclosures, little is known about firms decisions to purchase tax services from professional services firms other than the auditor because these choices are not observable. Understanding how firms choose among professional services firms to purchase tax services is important for understanding variation in firms tax reporting and avoidance behavior. Correspondingly, understanding how public accounting firms compete for tax clients is important due to the economic significance of tax service revenues to public accounting firms in the post Sarbanes-Oxley period (DeFond and Francis 2005) and the increase in competition from law and consulting firms for clients and tax experts due to these regulatory changes (Maydew and Shackelford 2007). Using data from the U.S not-for-profit (NFP) sector where the decision to purchase tax services is observable for all organizations, this study investigates the determinants and consequences of NFP organizations decisions to purchase tax services from among the financial statement auditor, another CPA firm, a law or tax consulting firm or to self-prepare the tax return. The NFP sector provides an advantageous setting for several reasons. First, the tax return is a public document for NFPs, thereby allowing identification of the tax-preparer, if any. Second, tax-exempt entities typically do not report material income tax accounts in their financial statements. We expect that, among NFP entities, the decision to purchase tax services 1 is weighted more heavily on compliance and tax avoidance rather than on financial statement benefits. Thus, this setting may provide a cleaner test of the determinants and consequences of tax provider choice because the financial statement benefits of tax planning are mitigated. Third, our primary variables of interest in examining the determinants of tax provider choice are based on geographic location and proximity to professional services. NFPs generally operate in a fixed geographical area and provide services in both urban and rural settings, thereby providing variation in availability and proximity of professional services. In contrast, public companies operate in multiple jurisdictions, may choose locations based on national, state, and local tax incentives, and may be constrained to purchase services from national or global network firms due to geographically dispersed operations. Fourth, tax avoidance and compliance among NFPs is an issue of growing public concern (GAO 2002; GAO 2008; Grassley 2006). Although the specific tax incentives differ between taxable and tax-exempt entities, NFP entities face substantial tax-related incentives, including tax avoidance on unrelated business income and the threat of losing tax-exempt status, particularly among hospitals. Finally, NFP organizations represent a sizable component of the U.S. economy, employing approximately 10% of the U.S. workforce (NCCS 2011), and contribute economically significant revenues to public accounting firms audit and tax practices. We first model the firm s decision to purchase tax services from the financial statement auditor, other CPA firms, law or consulting firms, or to self-prepare the tax return. We draw upon the organizational studies literature on professional services firms (Chase and Tansik 1983; Covaleski et al. 2003; Malhotra and Morris 2009; Malhotra et al. 2006; Morris and Empson 1998) to study whether the factors that influence organizational differences across professions client proximity and the availability of knowledgeable professionals - explain clients choices to 2 purchase tax services. Proximity to clients is important when providing high-contact services such as financial statement audits (Chase and Tansik 1983; Malhorta and Morris 2009). However, product innovation drives competitive advantage in tax services (Morris and Empson 1998), and tax partners incur significant costs when changing professional services firms (Maydew and Shackelford 2007). Thus, it is unclear ex-ante how clients will trade-off proximity and product innovation when choosing a tax provider. Knowledge availability facilitates resource allocation through the use of teams within professional services firms (Morris and Empson 1998), allowing for greater customization of services to meet individual client needs. Thus, clients located in areas with greater tax knowledge availability may have more choices for customized tax services. Finally, we control for determinants of investment in tax planning, following Mills et al. (1998), and client specific attributes. Our measure of knowledge proximity is the distance between the client and the financial statement auditor. Our measures of knowledge availability are the number of accountants and auditors employed in the local market, the number of professional services firm offices providing NFP tax services in the state, and an indicator variable for NFPs located in rural areas. Using multinomial logistic regression analysis on a sample of 1,173 unique not-for-profit organizations between 2004 and 2006, we find that NFPs are more likely to hire another CPA firm and are less likely to self-prepare as the number of accountants employed in the NFP s local MSA increases. NFPs located in rural areas are significantly less likely to hire a CPA firm other than their auditor and NFPs located in states with the greatest availability of knowledge have higher odds of retaining a law or tax consulting firm than the financial statement auditor. Finally, we find that greater distance between the client and the auditor increases the probability of hiring other professional services firms or self-preparing the tax return. These findings are consistent with 3 the notion that audit clients are less likely to purchase auditor-provided tax services when the availability of professional services is greater and as distance to their financial statement auditor increases. Our findings suggest that the availability and proximity of tax knowledge are significant determinants in the organization s choice of tax service provider and, correspondingly, the extent to which public accounting firms compete with other professional services firms for non-audit service revenues. This analysis also reveals insights into the role of determinants of investment in tax planning and firm-specific characteristics on the decision to purchase outside tax services. Consistent with Mills et al. (1998), we find that, in general, determinants of investment in tax planning are positively associated with the decision to self-prepare the tax return. Second, Big N audit clients are significantly more likely to use a tax or consulting firm, or to self-prepare the tax return, than to retain their auditor for tax services. Finally, we find that NFP organizations whose CFOs have management, rather than accounting, backgrounds are more likely to choose another professional services firm over the financial statement auditor and that CFOs with accounting backgrounds are significantly less likely to self-prepare the tax return. Our second analysis examines stakeholder perceptions of NFPs choice of tax service provider or self-preparing the tax return. Unlike public companies, the tax return, rather than the audited financial statements, is the primary document NFPs use to communicate financial, operating, tax, and governance data to donors and other outside stakeholders. We find that NFPs that self-prepare the tax return receive significantly lower contributions from the public and that firms changing from a professionally prepared tax return to a self-prepared return receive significantly lower contributions from the public and the government in the following year. 4 These findings suggest that donors attach lower credibility to financial and tax information provided by NFPs that self-prepare their public tax returns. Finally, we conduct a supplemental analysis which examines whether knowledge availability and proximity are associated with SEC registered firms choices to purchase tax services from the auditor. We find inferences consistent with our analysis of NFP organizations and document that public companies are less likely to purchase auditor-provided tax services as distance to the auditor and knowledge availability increase. This study makes several contributions to the literature. First, we contribute to the literature on auditor-provided tax and non-audit services by providing empirical evidence on audit clients decisions to purchase tax services from other professional services firms or to selfprepare the tax return. Prior research on auditor-provided tax services often concludes that financial reporting benefits due to knowledge spill-over or efficiency of audit and tax services influence a firm to hire their auditor for tax services. However, given these documented benefits, the only explanation in the literature for why firms do not choose their auditor for these services is the perception of auditor independence. We provide initial evidence of two additional factors, knowledge availability and proximity, which influence a firm s decision to hire a tax service provider. 1 Thus, perceived independence issues may only be one possibility that explains a firm s choice to employ a provider other than their auditor for tax services. Although our sample selection procedures preclude a direct analysis of industry competition or concentration for tax services in the NFP sector, our findings suggest that among NFP clients, Big N firms may face greater competition for tax service revenues from non-cpa firms and internal resources than from other CPA firms. 1 As discussed in the research design section, our sample consists of one half of the large NFP organizations with available data from NCCS and the Census department. In 2006, NFPs in our sample held over $400 billion in total assets and received over $50 billion in federal funds. 5 Second, we contribute to the literature on tax reporting and avoidance behavior among NFP organizations (Krishnan et al. 2006; Yetman 2001; Omer and Yetman 2003; Omer and Yetman 2007; Yetman and Yetman 2008; Sansing 1998; Roberts 2005; Keating et al 2008; Leone and Van Horn 2005; Sansing 2000) by providing evidence on how NFP organizations choose among professional services firms for outside tax services. Third, we contribute to the growing literature on the effects of managers individual traits on their firms financial reporting, disclosure, and tax avoidance decisions (Bamber et al. 2010; Bertrand and Schoar 2003; Dyreng et al. 2010; Ge et al. 2011) by documenting an association between the CFO s prior work experience and tax provider choice. Fourth, to our knowledge, our study is the first to incorporate the effect of knowledge availability and proximity to professional services on firms decisions to purchase tax services. Our findings that NFPs are more likely to choose tax providers in the local market suggests that, like audit services, client proximity is an important service aspect of external tax services. We also contribute to the literature on donor and funding agency perceptions of financial reporting quality among NFP organizations (Petrovits et al. 2011), as well as, public perceptions of professional tax services by providing evidence on financial statement users decisions to reduce contributions to firms that self-prepare the tax return. This evidence suggests that external tax services enhance the reliability and credibility of financial information provided by a NFP organization. Finally, our study is relevant to practitioners and donors by explaining NFPs decisions when purchasing external tax services and to NFP organizations by providing evidence on donors and funding agencies perceptions of self-prepared tax returns. 6 This study proceeds as follows: Section II provides background information and develops our hypotheses. Section III details the research design. Section IV describes our sample, Section V discusses our empirical results, and Section VI concludes. II. BACKGROUND AND HYPOTHESIS DEVELOPMENT Background Information on Tax Reporting in the Not For Profit Sector The NFP sector comprises a significant portion of the U.S. economy; million NFP organizations were registered with the IRS in NFP organizations contribute 5% of GDP and employ 10% of the U.S. workforce (IRS 2010; NCCS 2011). The growth in the NFP sector has attracted scrutiny from the GAO and U.S. Congress because NFPs face fewer regulations than taxable organizations and may exploit their tax-exempt status to earn economic rents at the expense of their for-profit counterparts (GAO 2002; GAO 2008; Grassley 2006; Grassley 2010; Carreyrou and Martinez 2008). Prior academic research provides some support for these concerns, documenting that NFPs misreport expenses to reduce taxable income and achieve other financial reporting objectives (Yetman 2001; Omer and Yetman 2003; Sansing 1998; Krishnan et al. 2006; Roberts 2005; Keating et al 2008; Leone and Van Horn 2005; Sansing 2000). Finally, the NFP sector is economically important to public accounting firms. Mean (median) fees paid for total outside accounting services within our sample in 2006 were $406,835 ($98,345), and many firms maintain specialized industry practices for governmental and NFP clients. McGladrey and PricewaterhouseCoopers maintain specialized NFP tax groups, and KPMG employs 1,400 dedicated partners and staff for governmental and NFP assurance and advisory clients (KPMG 2011). 7 Background information on non-audit service revenue Public accounting firms have earned economically significant revenues from non-audit services (NAS) since the 1970s (Zeff 2003a, b; Kinney 2005) and by 2000, tax and management consulting fees exceeded 50% of gross fees for each of the Big 5 firms (Zeff 2003b). Regulators and investors have consistently expressed concern that the provision of NAS to audit clients may potentially compromise auditor independence due to economic bonding between the auditor and client. However, firms may benefit from auditor-provided NAS due to knowledge spillover or efficiencies gained by the joint provision of audit and non-audit services. Prior research documents mixed evidence suggesting that the provision of NAS impairs audit quality using measures such as discretionary accruals, restatements, and opinion modification (DeFond et al. 2002; Frankel et al. 2002; Larcker and Richardson 2004; Reynolds et al. 2004; Ashbaugh et al. 2003; Antle et al. 2002; Chung and Kallapur 2003; Raghunandan et al. 2003; Agrawal and Chadha 2005; Kinney et al. 2004; Craswell et al. 2002; Francis 2006; Gaver and Patterson 2007; Chen et al. 2010). However, other studies document potential benefits to NAS, particularly tax services, due to knowledge spill-over or efficiencies gained by the joint provision of audit and tax services (Antle et al. 1997; Pitt and Birenbaum 1997; Kinney et al. 2004; Gleason and Mills 2002; Gleason and Mills 2011; McGuire et al. 2011; Bedard et al. 2010; Cook et al. 2008; Beck, et al. 1988; Robinson 2008). The Sarbanes-Oxley Act banned the provision of most non-audit services to audit clients, including some tax consulting services (SEC 2002, 2003). 2 These regulatory changes prompted restructuring of the market for tax services as many firms discontinued auditor-provided tax 2 Although NFP organizations are not regulated by the U.S. Securities and Exchange Commission, public accounting firms may adopt SEC policies across all clients to standardize audit practices and policies. Further, many states have considered legislation that would subject NFPs to regulations similar to SOX. See Petrovits et al. (2011) for further discussion of state initiatives to increase oversight of the NFP sector. 8 services due to concerns surrounding auditor independence (Maydew and Shackelford 2007; Cook and Omer 2011). Although tax revenues earned by the Big 4 firms and larger national firms increased over this period (Public Accounting Report 2008), tax fees paid by audit clients declined in the years following SOX (Bédard and Paquette 2010; Maydew and Shackelford 2007), consistent with a shift in tax revenues from audit to non-audit clients. Further, law and consulting firms expanded their tax practices following SOX, including hiring tax experts away from public accounting firms (Maydew and Shackelford 2007). Maydew and Shackelford (2007) report that PricewaterhouseCoopers lost 3% of its tax practice to law firms following SOX. Hypotheses An important limitation of the literature on NAS is that clients decisions to purchase NAS, if not from the auditor, are unobservable. Given the economic importance of NAS to public accounting firms and the restructuring of the market for tax services following the regulatory changes in SOX, we explore clients decisions to purchase tax services in the NFP sector where the decision to purchase tax services is observable for all organizations. Because public accounting firms compete with other professions and internal client resources for tax clients, we draw upon the organizational
Search
Related Search
We Need Your Support
Thank you for visiting our website and your interest in our free products and services. We are nonprofit website to share and download documents. To the running of this website, we need your help to support us.

Thanks to everyone for your continued support.

No, Thanks