Corporate scandals and general public concerns led to increased external monitoring activity by tax and financial reporting authorities in the early 2000s. Such increased monitoring was a response to a suspected increase in tax avoidance activities (U.S. Treasury, 1999) and a deterioration of corporate governance institutions (Coffee, 2006).2 Specifically, the IRS increased both reporting requirements and audit activity in an effort to reduce tax avoidance and Congress empowered the SEC, through the Sarbanes-Oxley Act of 2002 (SOX), to increase internal control requirements for publically traded firms. In this paper, I provide evidence regarding whether tax avoidance did in fact decrease following the changes in external monitoring. Furthermore, I examine whether firms with weaker corporate governance in the 1990s exhibited lower tax avoidance levels than other firms after the regulatory regime changed.3 Such weaker corporate governance firms were probably affected to a greater extent than other firms by regulatory regime changes because they were most likely to have weaknesses in their internal controls (Hoitash, Hoitash, & Bedard, 2009; Krishnan, 2005). Therefore, they may have invested resources to improve their internal controls and eliminated certain risks from their tax avoidance activities (KPMG, 2006) that would result in lower tax avoidance levels relative to other firms. My study extends and contributes to our understanding of the interplay between external and internal corporate governance mechanisms on corporate tax avoidance and it is of interest to regulators and academics. I define tax avoidance as a reduction on a corporation’s explicit taxes that do not distinguish between real activities undertaken to reduce tax liabilities and targeted tax benefits from lobbying activities (Dyreng, Hanlon, & Maydew, 2008; Hanlon & Heitzman, 2010) nor from those activities that are considered outright illegal tax evasion. This definition fits the context of my study because the effect of increased regulation throughout this period affected areas of tax reporting that transcended tax sheltering activities. In my analyses, I use estimated permanent book-tax differences and cash effective tax rates (ETR) to measure firms’ tax avoidance levels. I implement a difference-in-differences design on an unbalanced panel of large U.S. firms for the period from 1997 to 2005 using fixed-effects regressions. To implement the difference-in-differences design and test the effect of regulation changes on firms’ tax avoidance levels, I create a discontinuity in the time series by eliminating years 2001–۲۰۰۲ (transition period) from the sample. The sample partition including years 1997–۲۰۰۰ (low-regulation period) captures the period where aggressive tax avoidance activity was booming and most of the highprofile accounting scandals (e.g., Enron, WorldCom) were underway but undetected. The sample partition including years 2003–۲۰۰۵ (highregulation period) captures the period where the IRS re-focused its efforts to curb aggressive tax reporting and the initiation of the SOX disclosure requirements. Then, I use firms’ governance strength during the late 1990s to test the effect of the regulatory regime changes in tax avoidance.