Page 80 - 33-2

Tax Avoidance and Financial Statement Readability: The Role of Industry Specialization Auditor

Financial statements are a major source of information that enables investors to
understand a firm’s performance and to evaluate the whole value of said firm. If the firm
provides readable financial reports, the information asymmetry between the firm and its
investors is minimized, and the agency cost is lowered. By contrast, when the readability

of a firm’s financial statements is lower, users of said firm’s financial reports are likely to
expend more time and effort to decipher the information hidden in the financial reporting.
Thus, additional agency costs are created. Previous studies have indicated that firm

managers who intend to conceal information tend to provide complicated financial reports
to hide the truth.
Based on the aforementioned, we predict that when a firm’s degree of tax avoidance
is higher, the corresponding higher potential risk and cost increase the firm’s motivation to
shelter its acts; that is, the firm is more likely to provide less readable financial statements

to hide its tax avoidance behavior in order to mitigate the negative impact of said behavior.
Thus, we develop the following hypothesis:
H1: A firm’s degree of tax avoidance is negatively related to the readability of its financial

statements.

Next, whether the auditor is an industry specialist is a major determinant of audit
quality. After accumulating professional knowledge and auditing experience related to
the industry in question, an industry-specialist auditor is well-equipped to understand the

characteristics of said industry; this greater understanding leads to higher audit quality
through the enhancement of the efficiency of the audit and improvement of the client’s
financial reporting quality. On the other hand, as an important monitoring role in the

information disclosure process, auditor industry expertise tends to maintain their expert
reputation. Having lower tolerance of litigation risk and keeping audit independence
in mind have prompted these industry-specialist auditors to compel clients to enhance
the quality of the disclosure and faithfully represent their discovered misstatements.
Therefore, we predict that industry-specialist auditors can prevent firms from providing

obscure financial reports to hide their tax avoidance activities. The hypothesis is developed
as follows.
H2: Industry-specialist auditors mitigate the negative relationship between tax avoidance

and financial statement readability.

72