LAUSR

Abstract Most governments attempt to fight and reduce tax evasion. A dilemma arises about whether policies should encourage the ethical behavior of firms (an informal institution) or strengthen auditing standards (a formal institution). In this study, we provide novel worldwide evidence on the effects of these two factors on tax evasion. Overall, even though strong auditing standards may mitigate tax evasion, the ethical behavior of firms has a statistically more robust effect in achieving this goal; these results hold after we control for endogeneity and different subperiods (before, during, and after the recent global financial crisis). More specifically, the ethical behavior of firms is effective for low- and middle-income countries with low and high levels of investor protection and low-efficacy corporate boards; however, ethical behavior and auditing standards are mutually effective for high-income countries and countries with middle level investor protection and middle- and high-efficacy corporate boards. Thus, this study provides useful insights for organizations and policy makers.