STRATEGIC CONSIDERATIONS FOR AN AUDIT GAME: TAX AUDIT CERTIFICATE

STRATEGIC CONSIDERATIONS FOR AN AUDIT GAME: TAX AUDIT CERTIFICATE Panayiotis D. Tahinakis University of Macedonia, Department of Accounting and Finance, 156, Egnatia str., 540-06, Thessaloniki, Greece, E-mail: tahi67@uom.gr, tel.: +302310891564 Michalis P. Samarinas University of Macedonia, Department of Accounting and Finance, 156, Egnatia str., 540-06, Thessaloniki, Greece, E-mail: msamarinas@uom.gr Abstract This paper attempts to model the strategic interactions between auditors and auditees in order to conceptualize the audit problem and inherent risk that arises from the adoption of an alternative to tax audit, namely tax audit certificate. The recent implementation of a tax audit in Greece, performed not by tax authorities but by auditing firms, created a rather unique phenomenon. Auditors, under fee, undertook both the obligation of ensuring and reporting firms tax conformity, essentially substituting Greek authorities. This development raised a series of issues concerning a new type of audit risk, related indirectly, with the provision of managerial and advisory services. Utilizing a rather stylized approach, based on a game theoretic framework, we attempt to examine at the same context, different issues like auditor s independence and audit fees, while addressing simultaneously tax conformity and tax evasion topics. Employing a non-cooperative, mixed strategy game, we try to emulate the behavioral patterns of auditor and auditee, thus investigating the effect that both parties create on each other, through a randomized strategies perspective. The results illustrate the conceptual issues involved in this audit-auditee strategic interactions game, providing a structure of choices that ensure socially optimal strategies. Key Words: Audit, Strategic Interaction, Tax Audit Certificate, JEL: M42 1. INTRODUCTION Since 2011 the Greek government amidst a Eurozone financial turmoil and a national sovereign debt crisis found itself in urgent need for increased public revenues, tax efficiency and minimization of tax evasion. Greek public economic reality has been accompanied by a problematic operation of tax services, various inefficiencies in the area of public revenues collection from taxation and in many cases a mentality of tax evasion adopted by Greek corporations. The authors would like to thank Professor Negakis Ι.C., Assistant Professor Kousenidis D., Dr. Ladas A. for their helpful suggestions and constructive comments during the preparation of this paper. 1

In many instances the inability of Greek state to impose reciprocal taxation as well as the failure of controlling the proper implementation of tax legislation and the enforcement of penalties to those that did not conform with it, created a vicious circle that can be described as a see no evil, hear no evil, speak no evil mentality from the government s side and a repeated offending behavior for many a companies in Greece. The structure of tax control had to be revisited and reviewed and thus the Tax Audit Certificate was applied in Greek financial reality with the Ministry of Finance Act No.1159/2011. With this Act, a systemization is attempted, so that a tax audit will be performed for every firm, at the end of each fiscal year. In this way tax authorities have been essentially substituted by Auditing firms and their role regarding the tax audit is therefore transferred to them. Tax Audit Certificate is the outward sign of a tax audit procedure, which is performed not by tax authorities but by auditing firms. This certificate is issued by the auditor who undertakes, under a fee, both the obligation of ensuring and reporting firms tax conformity, essentially substituting Greek authorities. An important fact that has to be duly noted is that tax auditing services are provided by auditing firms, simultaneously with the regular auditing services. This fact constitutes the focal point of this research paper, since it subsequently implies, that tax audit certificate could be regarded as a distinct service from those that regularly auditors provide. Tax audit certificate could represent a non-audit service with audit characteristics, but with all the particularities that could weaken auditor s independence. Taken in that context a series of issues arise. Tax audit certificate creates a solution for tax audit, providing an uninterrupted and systematic control environment, in which audited firms have an extra incentive to conform with, tax legislation. But does this provision of a non audit service 1 raises questions about auditor s independence? Does the provision of an audit restricted until recently for tax authorities, severely impairs the ability for an efficient tax audit? Does the substitution of tax authorities by auditing firms can obstruct the Greek government s goal for increasing tax revenues? Keeping in mind the above mentioned questions we attempt to see the bigger picture. We attempt to understand whether we can map the issues raised and recognize the different aspects of this problematic framework, while simultaneously we try to find the socially optimal balance. Therefore the questions alter and focus on whether there can be a modeling of the strategic interactions between auditors and auditees. In other words, is there a way to conceptualize the audit problem and inherent risk that arises from the adoption of an alternative to tax audit, namely tax audit certificate? Is there a robust way to provide a structure of choices that ensures comprehension of the actions of both parties 1 We refer to this kind of services as non-audit since despite they concern an audit activity they do so regarding tax legislation conformity. It has to be understood that in Greece accounting reporting and tax reporting are distinct activities. The first is in accordance to IFRS, while the other is in accordance to Greek GAAP. Furthermore, Greek tax legislation commands conformity with a series of obligations and legal requirements for Greek firms which have to be met, in order for those companies to be tax compliant. In this context the regular audit procedure bears only minor resemblances to tax audit activity, hence generating a completely distinct service for audit firms that are going to engage with the preparation of tax audit certificate. 2

and theirs effects? Is there a robust way to provide a structure of choices that ensures the representation of all socially optimal strategies? The remainder of the study is formulated as follows: Section 2 provides a background analysis of tax audit certificate and a review of previous literature and research concerning the matter, while section 3 elaborates on methodological issues focusing to the model construction of our game theoretic approach. Section 4 presents the results of modeling these strategic interactions and finally Section 5, provides the concluding remarks of the paper with our proposals for future research. 2. BACKGROUND AND RELATED RESEARCH The Ministry of Finance Act No.1159/2011 provided us with a rather detailed framework of this new tax audit by auditing firms. It provided information about the auditor s obligations and fees, the method of preparation of a Tax Compliance Report and the different classifications of tax audit opinion that can be expressed by the auditor, accompanied of course by the actions taken by tax authorities for each audit opinion. More specifically, the most important provisions of this Act can be summarized as follows. Tax Audit Certificate is issued yearly and its preparation is mandatory. Any tax offences, including tax payment avoidance, or incorrect tax payments found in the company s records, should be reported extensively to this certificate by the auditor, composing a base for the subsequent tax treatment allocation, the potential penalty enforcement or any other legal action by tax authorities. If the certificate establishes auditee conformity and does not report any tax offences, the regular statutory tax audit is not performed. In every other case the tax authorities are addressing the issue, performing a tax audit, first of all to validate firm s non - compliance and second to adjudge the proper legal action and/or penalties to the offender. It has to be noted that auditors are responsible for their tax audit. Any kind of errors or other discrepancies related with their audit makes them legally liable. Moreover, auditors performing this tax audit are entitled to a fee which is not subject to any regulation, but it is agreed between the two parties 2. It can be easily understood that as with regular audit, the tax audit remuneration depends vastly to the time spent, and the difficulties of the performing procedure. As mentioned earlier the auditor performing the tax audit, also bears the responsibility to express an opinion regarding his/her findings during the tax audit. For this reason the Tax Audit Certificate legislation incorporates a tax audit opinion classification that should be incorporated to the report generated for this reason, namely tax compliance report. The first opinion type that needs to be mentioned is presented in the Unqualified tax compliance report. This type of report represents a firm that is tax compliant, and therefore not subject to a regular statutory tax audit. The second opinion type is described in the Unqualified Tax Compliance Report with emphasis to certain issues. This type of tax audit opinion depicts a firm with minor tax compliance issues that are described in detail in the report provided by the auditor. In this case, the dilemma of whether a 2 Auditor and auditee 3

regular statutory tax audit will be performed or not, depends in the severity of the tax compliance offences found, and the cost benefit analysis between the penalties that will be collected and the amounts paid for the performance of this additional audit. The third opinion type bears the most severity since it represents a Qualified tax compliance report. In this case, the auditor expresses an opinion that concerns a non tax compliant firm. This type of report describes extensively, both the various tax offences and justifies the reasons for the utilization of such an opinion expression. This type of opinion leads to a regular statutory tax audit and tax authorities take the appropriate legal action to address the issue. Taking all of the above under consideration and keeping in mind our research focus it s only natural to wonder about the audit problem and inherent risk that arises from the adoption of an alternative to tax audit, namely tax audit certificate. Our research vacillates between auditor independence on the one side and the examination of auditor auditee relationship on the other. The issue of addressing auditor s independence has been one of the focal points in accounting and auditing literature. Specifically, the effect of the provision of non audit services to an audit client on the auditor s independence has been addressed by various papers such as Dopuch & King, (1991), Joe & Vandervelde, (2007), Raghunandan, (2003), Krishnan et al., (2005), Cahan et al., (2008), Quick and Warming-Rasmussen, (2009), or Ahadiat, (2011). Previous research (Johnstone & Bedard, 2001) used proxies for independence, qualifications or disclaimers of audit opinions or going concern opinions, such as Craswell et al., (2002), DeFond et al., (2002) and Geiger & Rama, (2003), while others utilized the degree of earnings management (Frankel et al., 2002; Ashbaugh et al., 2003; Chung & Kallapur, 2003; Larcker & Richardson, 2004; Ferguson et al., 2004; Dee et al., 2005; Huang et al., 2007) to investigate a potential relation. Most studies reported a negative effect on perceived independence, thus confirming that the provision of non audit services can have a seriously negative impact on auditor s independence. The twist in our case comes from researching the tax audit certificate phenomenon. The inherent audit risk of every auditing procedure (Shibano, 1990), is also existent in the case addressed in this paper. Therefore, our research focal point seems to refer to wide variety of issues dealt by auditing literature (auditor s independence, audit risk, optimum penalty for tax offences). The different aspects of this problematic framework can only be addressed simultaneously via a game theoretic framework. The attempt to find the social optimum that explains and optimizes both parties choices as well as those choices made by the government has not been made frequently in auditing literature. Fellingham and Newman, (1985), Fellingham et al., (1989), Shibano, (1990), Cook et al., (1997), addressed similar issues utilizing a decision theory framework but in general it would be safe to say that the issue at hand employing a game theoretical framework is far from researched in depth. 3. MODEL CONSTRUCTION Utilizing a rather stylized approach, based on a game theoretic framework, we attempt to examine, different issues like auditor s independence and audit fees, while addressing simultaneously tax conformity and tax evasion topics. This research paper constitutes an attempt to capture and model 4

the strategic relations between auditor and auditee and provide a structure of choices that ensures comprehension of the actions of these parties and their subsequent effects. In other words it constitutes a robust way to provide a structure of choices that ensures the representation of all socially optimal strategies. Employing a non-cooperative, mixed strategy game, with complete information we try to emulate the behavioral patterns of auditor and auditee, thus investigating the effect that both parties create on each other, through a randomized strategies perspective. The model of the auditing process investigated here regarding tax audit certificate is structured upon two basic axis, namely the auditee and the auditor. The choices which initially concern the auditee are: H = providing high levels of effort in processing accounting information and conform with tax legislation, and L = providing a low level of effort in processing such information and conforming with tax legislation. Choosing either H or L the auditee can end up in front of two more choices. These are either: TC = Tax Compliant NTC = Non Tax Compliant Both of these choices constitute the outcome of the effort in processing accounting information, conforming with tax obligations deriving from tax legislation, or embracing the mentality of tax evasion. Naturally, the bigger the effort to conform with tax legislation, the more certain it becomes for a firm to be tax compliant. In order to complete our design of the auditor-auditee strategic interactions structure we have to recognize and describe the decisions that represent the choices that the second pole of this relation has regarding Tax Audit Certificate. In this context the strategic options that the auditor is able to choose from, can be categorized into three broad groups of decisions. In other words we are referring into three different levels of options. these can be summarized as follows: 1. An investigation of the auditee's level of effort in assuring tax compliance, 2. A series of more extensive tests to check for any tax compliance offences in the information provided 3. 3. A decision on whether or not to provide a qualified certificate. Any one of these three groups of choices include options for the auditor that can affect the final outcome and probably the optimization of the choice. Thus the auditor's strategy involves choices between: EF 1 = High effort by the auditor in observing the auditee's level of care regarding tax compliance, which will allow the auditor to correctly assess the auditee's tax conformity, 3 Such an extensive test requires more audit time on behalf of the auditor and probably a bigger fee 5

EF 2 = Νo effort made by the auditor to assess the level of care regarding tax compliance, and hence no knowledge of the auditee's tax conformity exists. This set of options describes the effort that the auditor performing the tax audit puts in order to validate the auditee's tax conformity. It can be easily understood that the higher the effort regarding auditor's tax audit the better the correct tax conformity assessment, and vice versa. The second set of options for the auditor can be described as group of choices balancing among the performance of an extended additional set of tests to ensure that the tax audit results are 100% valid and the lack of additional effort in order to check for tax compliance offences. Thence there are choices between: ET 1 = An extended test of the accounting information to check for tax compliance offences, ET 2 = A less or no, extensive test of the accounting information that is less capable of deducing whether there are tax compliance offences. It has to be understood that this level of options for the auditor, means that both choices provided, represent more audit time, a fact that in most cases will affect not only audit fee, but also the ability of the auditor to detect tax compliance offences. In their turn the extended tax conformity tests can provide the auditor with two types of choices: RC = when no underlying tax compliance offences can be detected NRC = when tax compliance offences are discovered As mentioned above, the higher the effort by the auditor, the easier it is to find a tax compliance offence. The outcomes in this case, concern whether a tax compliance offence is detected or not. It has to be duly noted that our attempt to capture the reality of the strategic interactions between auditor and auditee means that we have to provide choices as close to the truth as possible, even if they seem to be not plausible. In other words, we describe choices were auditors can discover tax compliance offences (NRC), even when in reality there are no real tax compliance offences (TC = Tax Compliance), and they can discover conformity, (RC) even when there are underlying tax compliance offences (NTC = No Tax Compliance). Finally the last options may seem to be two (Q, ), but in reality there are four actual strategic choices for the auditor who determines whether to qualify the Tax Audit Certificate. These are: Q = Qualify, no matter what the Extended tax conformity test reports, = Not qualify, no matter what the Extended tax conformity test reports, R = (Reasonable) = Qualify (Q), if the Extended tax conformity test, reports tax compliance offences, otherwise do Not Qualify (), U = (Unreasonable) = Do Not qualify (), if the Extended tax conformity test, reports tax compliance offences, otherwise Qualify (Q). In this case we borrow the Fellingham and Newman, (1985) classification to cover all strategic options. While the outcomes can be a Qualified or a Non-Qualified Tax Compliance Report we provide four different choices, depending on the reasoning for this qualification. In this context we 6

can have an auditor that provides Q or regardless of the extended tax conformity test reports. We can also have a reasonable Q or depending on the outcomes of the Extended tax conformity test, or a completely unreasonable Q() that is provided even when Extended tax conformity test preconceive a completely opposite audit opinion. For example it seems unreasonable for a procedure that through an Extended tax conformity test discovers tax compliance offences, not to report them and provide a qualification for them. Considering all of the above mentioned choices, the extensive form of this game's choices is represented in the following graph: Graph 1 - Auditor - Auditee extensive form game, regarding tax audit certificate Note: The choices that appear in blue represent the strategic options, potentially eligible by the auditee, while the red represent the eligible auditor's options. For reasons of size the NTC and L branch of the extensive form are omitted. The different strategic choices in this auditor - auditee structure that have been analysed previously are not equally probable to be chosen. In other words some of the choices provided bear more or less probability to be made. For this reason it is only natural to define the probabilities for each choice in order to provide later on a calculation of this structure's payoffs. again we keep an analogous distinction between the choices of the auditee and the auditor. So the conditional probabilities for the auditee's choices are defined as follows: 7

a=p NTC H, the probability that the accounting information does not conform with tax legislation, if the auditee applies high effort (H), b = P NTC L, the probability of the accounting information does not conform with tax legislation, if the auditee applies low effort (L) These probabilities embody both the levels of strategic options made by the auditee, not only in terms of effort in treating accounting information and conforming with tax legislation, but also for the outcome of this effort which can be either TC or NTC. On the other hand the conditional probabilities for the auditor's choices are defined utilizing all three levels of strategic options, regarding the effort made by the auditor, the potential extended test that will be performed, and of course the outcome of this audit (either qualified or not). Hence the conditional probabilities for the auditor's choices are defined as follows: c = P NRC NTC,ET 1, the probability that Extended tax conformity test (ET 1 ), identifies tax compliance offences (NRC), given the fact that the auditee is Non Tax Compliant (NTC). d = P NRC TC,ET 1, the probability that Extended tax conformity test (ET 1 ), identifies tax compliance offences (NRC), given the fact that the auditee is Tax Compliant (TC). e = P NRC NTC,ET 2, the probability that a less or a non performed Extended tax conformity test (ET 2 ), identifies tax compliance offences (NRC), given the fact that the auditee is Non Tax Compliant (NTC). and f = P NRC TC,ET 2, the probability that a less or a non performed Extended tax conformity test Extended tax conformity test (ET 2 ), identifies tax compliance offences (NRC), given the fact that the auditee is Tax Compliant (TC). In order for our analysis to proceed we need to make an assumption regarding conditional probabilities of each of the above mentioned choices of the auditor. It seems to us relatively straightforward to assume that the probability (c) or (e) is bigger than (f) or (d). It seems compelling in our minds that the probability of an "unreasonable" series of auditor choices like (f), (a tax compliant auditee to be discovered with tax offences even if no extended tests have been made) cannot be bigger than the probability for a more reasonable set of auditor choices (c). For this reason the mathematical representation of this assumption is formulated as follows: c e f d, After attributing conditional probabilities for each of the strategic choices, we need to estimate the costs for each of the options that the auditor or auditee, are allowed to make. Both parties' choices are subject to a series of costs. These costs can be derived from carrying out the audit, they can be direct costs resulting from undertaking the work (either as auditor or auditee) and also the tax (and possible judicial) penalties of the outcome of the audit. Every strategic option that each of the game's players choose bears cost either as an audit fee, as a fee to the company's accountant, as a penalty for not conforming with tax legislation, but also as an indirect cost of loosing reputation. To the latter 8

(indirect) costs it is also crucial to incorporate the "social" costs for not qualifying when a tax offence exists and vice versa. In this model the costs for each strategic option is defined as follows: C EF = the auditor's cost of putting high effort in the audit of auditee' s tax compliance (EF 1 ), (the cost of test EF 2 is set as zero), C ET = the auditor's cost of undertaking an extended test for tax compliance (ET 1 ), (the cost of test ET 2 is set to zero), D H = the auditee's cost of applying high effort to processing the accounting information and being tax compliant, (the cost of low effort is set as zero), (D Q NTC ) = the expected cost to the auditor (auditee) of qualifying when there is really a tax compliance offence, C NTC Q (D Q TC ) = the expected cost to the auditor (auditee) of qualifying when there is no tax compliance offence, C TC Q (D NTC ) = the expected cost to the auditor (auditee) of not qualifying when there is really a tax compliance offence C NTC (D TC ) = the expected cost to the auditor (auditee) of not qualifying when there is no tax compliance offence. C TC As done with conditional probabilities an assumption has to be made for the costs regarding each strategic option following Cook et. al (1997). Considering the potential costs and penalties we must assume that the cost for the society of not qualifying an audited firm that is non tax compliant, will be bigger than not qualifying a tax compliant auditee. Proportionately qualifying an auditee which is tax compliant will have a bigger cost from qualifying some audited firm that is non tax compliant. The same logic applies for the auditee costs as well providing the following inequalities between the costs: and: C NTC C TC Q C NTC Q C TC D NTC Q D TC Q D TC and D NTC D TC 4. MODELLING STRATEGIC INTERACTIONS RESULTS The game constructed to represent the relation and strategic interactions between auditor and auditee in the context of tax audit certificate provides us with a number of strategies that can constitute the game equilibria. In its normal form, the game has only two strategies for the auditee - whether to put high (H) or low (L) effort into processing the accounting information and be tax compliant. 9

On the other hand the auditor has 72 possible pure strategies. Of these 72 strategies, 8 involve choosing EF 2 initially. This means that because of the low or no effort made by the auditor for the tax audit, no knowledge of the auditee's strategy can exist. The auditor's option for these 8 strategies is then followed by playing either ET 1 or ET 2 and then deciding on one of Q,, R, or U for qualifying the audit tax certificate. These eight strategies are represented as [EF 2 /ET 1 /Q], [EF 2 /ET 1 /], [EF 2 /ET 1 /R], [EF 2 /ET 1 /U], [EF 2 /ET 2 /Q], [EF 2 /ET 2 /], [EF 2 /ET 2 /R] and [EF 2 /ET 2 /U], respectively. Each of the symbols used for each strategy, represents the series of options made by the auditor in each case. On the other hand, choosing EF 1 initially concerns the remaining 64 strategies (72-8). In other words if a high auditing effort was made by the auditor then he must know whether the auditee has played H or L. Subsequently he can then make one of eight choices utilizing a combination of different extended tests, ET 1 or ET 2, and then deciding on one of Q,, R, or U for qualifying the audit tax certificate. The same applies for the rest. These strategies are represented as follows: EF 1 /1Q/2R, Where: i. the first implies EF 1 was chosen and high effort has been made from the auditor during the tax audit procedure, ii. 1Q represents the auditor's choice if the high auditing effort (EF 1 ) finds that the auditee has put in high effort (H) to be tax compliant, iii. 2R describes the auditor's choice if the high auditing effort (EF 1 ) finds that auditee has put in low effort (L) to be tax compliant. In order to find the solution for the game created we adopt for this non-cooperative game mixed strategy game the Nash equilibrium for mixed strategies. As with Cook et. al (1997), when the auditor plays strategy x and the auditee plays strategy y, the auditor's cost is defined as C(x,y) and the auditee's expected cost is defined as D(x,y). Considering that in order for x *, y* to be an equilibrium pair the following inequalities has to apply: C(x*, y*) C(x, y*) x (1) D(x*, y*) D(x*, y) y (2) The game constructed in the context of the tax audit certificate to describe the strategic interaction between auditor and auditee is a game with a finite number of pure strategies. In this case there is at least one Nash equilibrium pair. In order to find these Nash equilibria for our game (since our payoffs cannot be exactly calculated) we can apply a different way of thinking. A strictly dominated strategy for the auditor cannot be part of an equilibrium pair since it cannot satisfy inequality (1). Therefore, in order to find the equilibria pairs we can identify some strictly dominated strategies and eradicate them from the game. For this reason we assume that (x') is a strategy for the auditor. In order for (x') to be a strictly dominated strategy for the auditor there needs to be another strategy x such that C(x,y) < C(x',y) for all strategies y of the auditee. 10

So identifying some strictly dominated strategies we can extract them leaving all the possible Nash equilibria pairs thus reducing the vast initial game. This is done as follows: i. [EF 2 /ET 1 /Q] is strictly dominated by [EF 2 /ET 2 /Q], and [EF 2 /ET 1 /] is strictly dominated by [EF 2 /ET 2 /]. ii. [EF 2 /ET 1 /U] and [EF 2 /ET 2 /U] are strictly dominated by [EF 2 /ET 1 /R] and [EF 2 /ET 2 /R], respectively. iii. EF 1 /1Q/-, EF 1 /1/-, EF 1 /1U/-, EF 1 /2U/-, EF 1 /-/1Q, EF 1 /-/1, EF 1 /-/1U, and EF 1 /-/2U are all dominated strategies. iv. Neither (EF 1 /x/ -,H) nor (EF 1 /-/x, L) can be equilibrium pairs for any choice of x. After identifying and excluding dominated strategies, the only possible pairs left, lead to the reduced normal game form which is depicted in Table 1 and contains potentially an equilibrium pair. Auditee Auditor Table 1- Auditor - Auditee Game Form regarding Tax audit Certificate H L [EF 2 /ET 1 /R] [EF 2 /ET 2 /Q] [EF 2 /ET 2 /] [EF 2 /ET 2 /R] C ET + prc Q NTC + p(1-r)c ΝQ Q NTC + t(1-p)c TC +(1 t)(1-p)c TC, D H + prd Q NTC + p(1- r)d ΝQ NTC + t(1-p)d Q TC +(1-t)(1-p)D TC pc NTC Q + (1 - p)c TC Q, D H + pd NTC Q +(1- p)d TC Q pc NTC + ( 1 - p)c TC, D H + pd NTC + ( 1 - p)d TC pvc Q NTC + p(1-v)c ΝQ NTC + w(1-p)c Q TC +(1- w)(1-p)c Q TC, D H + pvd NTC + p(1- v)d ΝQ Q NTC + w(1- p)d TC +(1-w)(l-p)D TC C ET + qrc NTC Q + q(1 - r)c NTC ΝQ + t(1 - q)c TC Q +(1 t)(1-q)c TC, qrd NTC Q + q(1- r)d NTC ΝQ + t(1-q)d TC Q +(1-t)(1-q)D TC qc NTC Q + (1 - q)c TC Q, qd NTC Q +(1- q)d TC Q qc NTC + ( 1 - q)c TC, qd NTC + ( 1 - q)d TC qvc Q NTC + q(1 - v)c ΝQ Q NTC + w(1 - q)c TC +(1- w)(1 - q)c TC, qvd Q NTC + q(1- v)d ΝQ Q NTC + w(1- q)d TC +(1-w)(l-q)D TC The payoffs estimated in this form for the eight possible pairs of strategic options between auditor and auditee contain one or more mixed strategy Nash equilibria. This represents for us a structure of choices from which the socially optimal strategies for this relation can be identified and analyzed furthermore. 5. SUMMARY AND CONCLUSIONS With Ministry of Finance Act No.1159/2011 the tax audit reality in Greece changed. A new relation between the auditor and the auditee has emerged. With this paper we attempted to map all the strategic interactions between auditor and auditee regarding the tax audit certificate and to provide utilizing a rather stylized approach, based on a game theoretic framework, the optimal strategy/strategies that an lead to equilibrium. In the context of tax audit certificate we attempted to examine, different issues like auditor s independence and audit fees, while addressing simultaneously tax conformity and tax evasion topics. We employed a non-cooperative, mixed strategy game, and tried to emulate the behavioral patterns 11

of auditor and auditee, thus investigating the effect that both parties create on each other, through a randomized strategies perspective. After the creation of the auditor-auditee relation structure and the definition of its parameters to estimate payoffs we attempted to estimate the game equilibrium. In order to achieve that we provided a reduced game form including all the possible Nash Equilibria and eradicating those strategies that was strictly dominated, thus utilizing mixed strategy games theory. Employing this non-cooperative, mixed strategy game, we attempted to emulate the behavioral patterns of auditor and auditee, thus investigating the effect that both parties create on each other, through a randomized strategies perspective. The results illustrated the conceptual issues involved in this audit-auditee strategic interactions game, providing a structure of choices that incorporate socially optimal strategies in the form of Nash Equilibria. Initial findings provided us with the basic structure, of the relationship researched, and minimized the possible strategies that can be utilized, to discover the optimum. However our ongoing research will allow us to actually provide a more close to reality equilibria estimation. The focal point of this endeavor is to provide simultaneously a sensitivity analysis of various conditional probabilities while at the same time a utilization of real costs and penalties data can help us identify the actual costs that produce equilibrium. Moreover understanding the narrow minded logic behind the pairs of choices we can incorporate especially for the strategic choices of the auditee more options like moderate effort. Taking this analysis even further, perhaps fuzzy logic could be applied. Finally a comparison of our structure with a newly introduced zero sum, mixed strategy game with incomplete information could provide us with interesting results. REFERENCES Ahadiat N., (2011) "Association between audit opinion and provision of non-audit services", International Journal of Accounting and Information Management, Vol. 19, pp.182-193 Ashbaugh, H., LaFond, R. & Mayhew, B. W. (2003), Do nonaudit services compromise auditor independence? Further evidence, The Accounting Review, Vol. 78, pp. 611 39. Cahan S.F., Godfrey J. M., Hamilton J. and Jeter D.C., (2008), Auditor Specialization, Auditor Dominance, and Audit Fees: The Role of Investment Opportunities, The Accounting Review, Vol. 83, pp. 1393-1423 Chung, H. & Kallapur, S. (2003), Client importance, nonaudit services, and abnormal accruals, The Accounting Review, Vol. 78, pp.931 55. Cook J., Hatherly D., Nadeau L., Thomas L.C., (1997), Does cooperation in auditing matter? A comparison of a non-cooperative and a cooperative game model of auditing, European Journal of Operational Research, Vol.103, pp. 470-482 12

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