Corporate Income Tax Changes in the Context of Earnings Management: a Review of the Literature

Olga Krzeczewska; Luís Miguel Serra Coelho

doi:10.18778/2391-6478.3.35.02

Authors

Olga Krzeczewska Univesity of Lodz, Faculty of Economy and Sociology https://orcid.org/0000-0003-3650-2152
Luís Miguel Serra Coelho School of Economics - University of the Algarve and CEFAGE-UALG https://orcid.org/0000-0002-8074-4194

DOI:

https://doi.org/10.18778/2391-6478.3.35.02

Keywords:

earnings management, tax incentive, tax rate change, tax reform

Abstract

The purpose of the article/hypothesis: This paper aims to provide a comprehensive review of the theoretical and empirical literature regarding tax-induced earnings management. In particular, the association between anticipated tax changes and earnings management is of interest to the authors.

Methodology: This paper uses a systematic literature review to achieve its research objectives.

Results of the research: The presented research is mostly devoted to tax rate decreases and focuses on accrual-based earnings management methods. In anticipation of a tax rate change, companies shift their income from a high to a low tax rate period. Moreover, the probability of tax-induced earnings management is higher in case of extreme changes in the tax rate, larger prospects for tax savings as well as in case of private firms. This paper identifies several inconsistencies and gaps in the current literature, emphasizing that the connection between firms’ characteristics, the level of book-tax conformity and the practice of earnings management remains unclear.

Downloads

Download data is not yet available.

References

Ali A., Bansal M., 2021, Impact of upward and downward earnings management on stock returns. South Asian Journal of Business Studies. https://doi.org/10.1108/SAJBS-12-2020-0417
Google Scholar DOI: https://doi.org/10.1108/SAJBS-12-2020-0417

Andries K., Cools M., Van den Abbeele A., Van Uytbergen S., 2014, Influence of financial reporting incentives on the use of the tax expense as an earnings management tool in private firms. In EAA (European Accounting Association) Annual Conference, Date: 2014/05/21-2014/05/23, Location: Tallinn, Estonia.
Google Scholar

Bai M., Song D., Li H., 2021, Anticipated Reductions in Tax Rates and Earning Management of Listed Companies: Evidence from China. Discrete Dynamics in Nature and Society, 2021 https://doi.org/10.1155/2021/4259484
Google Scholar DOI: https://doi.org/10.1155/2021/4259484

Ball R., Shivakumar L., 2005, Earnings quality in UK private firms: comparative loss recognition timeliness. Journal of accounting and economics, 39(1), pp. 83–128 https://doi.org/10.1016/j.jacceco.2004.04.001
Google Scholar DOI: https://doi.org/10.1016/j.jacceco.2004.04.001

Blaylock B., Gaertner F., Shevlin T., 2015, The association between book-tax conformity and earnings management. Review of accounting studies, 20(1), pp. 141–172 https://doi.org/10.2139/ssrn.1983107
Google Scholar DOI: https://doi.org/10.1007/s11142-014-9291-x

Boynton, C. E., Dobbins, P. S., & Plesko, G. A., 1992. Earnings management and the corporate alternative minimum tax. Journal of Accounting Research, 30, pp. 131–153.
Google Scholar DOI: https://doi.org/10.2307/2491198

Coppens L., Peek E., 2005, An analysis of earnings management by European private firms. Journal of international accounting, auditing, and taxation, 14(1), pp.1–17 https://doi.org/10.1016/j.intaccaudtax.2005.01.002
Google Scholar DOI: https://doi.org/10.1016/j.intaccaudtax.2005.01.002

Dhaliwal D. S., Gleason C. A., Mills L. F., 2004, Last‐chance earnings management: using the tax expense to meet analysts' forecasts. Contemporary accounting research, 21(2), pp. 431–459 https://doi.org/10.1506/TFVV-UYT1-NNYT-1YFH
Google Scholar DOI: https://doi.org/10.1506/TFVV-UYT1-NNYT-1YFH

Dutzi A., Rausch B., 2016, Earnings management before bankruptcy: A review of the literature. Journal of Accounting and Auditing: Research & Practice, 2016(2016), pp. 1–21 https://doi.org/10.5171/2016.245891
Google Scholar DOI: https://doi.org/10.5171/2016.245891

Erickson M., Hanlon M., Maydew, E. L., 2004, How much will firms pay for earnings that do not exist? Evidence of taxes paid on allegedly fraudulent earnings. The Accounting Review, 79(2), pp. 387–408 https://doi.org/10.2308/accr.2004.79.2.387
Google Scholar DOI: https://doi.org/10.2308/accr.2004.79.2.387

Goncharov I., Zimmermann J., 2006, Earnings management when incentives compete: the role of tax accounting in Russia. Journal of International Accounting Research, 5(1), pp. 41–65 https://doi.org/10.2308/jiar.2006.5.1.41
Google Scholar DOI: https://doi.org/10.2308/jiar.2006.5.1.41

Guenther D. A., 1994, Earnings management in response to corporate tax rate changes: Evidence from the 1986 Tax Reform Act. Accounting Review, pp. 230–243.
Google Scholar

Hashim J., Haniff M. N., Rahman I. K. A., 2012, Tax waiver year effect on earnings management practices in Malaysia. Journal of Financial Reporting and Accounting https://doi.org/10.1108/19852511211273714
Google Scholar DOI: https://doi.org/10.1108/19852511211273714

Healy P. M., Wahlen, J. M., 1999, A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), pp.365–383 https://doi.org/10.2139/ssrn.156445
Google Scholar DOI: https://doi.org/10.2308/acch.1999.13.4.365

Hu N., Cao Q., Zheng L., 2015, Listed companies' income tax planning and earnings management: Based on China's capital market. Journal of Industrial Engineering and Management (JIEM), 8(2), pp. 417–434 https://doi.org/10.3926/jiem.1310
Google Scholar DOI: https://doi.org/10.3926/jiem.1310

Hung M., 2001, Accounting standards and value relevance of financial statements: An international analysis. Journal of accounting and economics, 30(3), pp. 401-420 https://doi.org/10.1016/S0165-4101(01)00011-8
Google Scholar DOI: https://doi.org/10.1016/S0165-4101(01)00011-8

Kałdoński, M., & Jewartowski, T. (2020). Do firms using real earnings management care about taxes? Evidence from a high book-tax conformity country. Finance Research Letters, 35(C), pp. 1–8 https://doi.org/10.1016/j.frl.2019.101351
Google Scholar DOI: https://doi.org/10.1016/j.frl.2019.101351

Karampinis N. I., Hevas D. L., 2013, Effects of IFRS adoption on tax-induced incentives for financial earnings management: Evidence from Greece. The International Journal of Accounting, 48(2), pp.218–247 https://doi.org/10.1016/j.intacc.2013.04.003
Google Scholar DOI: https://doi.org/10.1016/j.intacc.2013.04.003

Lin B., Lu R., Zhang T., 2012, Tax-induced earnings management in emerging markets: Evidence from China. Journal of the American Taxation Association, 34(2), pp. 19–44 https://doi.org/10.2308/atax-10236
Google Scholar DOI: https://doi.org/10.2308/atax-10236

Lin K. Z., 2006, The impact of tax holidays on earnings management: An empirical study of corporate reporting behavior in a developing-economy framework. The International Journal of Accounting, 41(2), pp.163–175 https://doi.org/10.1016/j.intacc.2006.04.006
Google Scholar DOI: https://doi.org/10.1016/j.intacc.2006.04.006

Lopez T. J., Regier P. R., Lee T., 1998, Identifying tax-induced earnings management around TRA 86 as a function of prior tax-aggressive behavior. The Journal of the American Taxation Association, 20(2), pp. 37–57.
Google Scholar

Marques M., Rodrigues L. L., Craig R., 2011, Earnings management induced by tax planning: The case of Portuguese private firms. Journal of International Accounting, Auditing, and Taxation, 20(2), pp.83–96 https://doi.org/10.1016/j.intaccaudtax.2011.06.003
Google Scholar DOI: https://doi.org/10.1016/j.intaccaudtax.2011.06.003

Monem R. M., 2003, Earnings management in response to the introduction of the Australian gold tax. Contemporary accounting research, 20(4), pp. 747–774 https://doi.org/10.1506/KC7W-C1VN-Y5D4-NAV4
Google Scholar DOI: https://doi.org/10.1506/KC7W-C1VN-Y5D4-NAV4

Moreira J., 2006, Are financing needs a constraint to earnings management? Evidence for private Portuguese firms. Discussion Papers, 10, pp. 1–33.
Google Scholar

Porcano T. M., 1997, An analysis of capital gains tax-induced earnings management. International Advances in Economic Research, 3(4), pp. 395–408 https://doi.org/10.1007/BF02295218
Google Scholar DOI: https://doi.org/10.1007/BF02295218

Public Law 99-514: Tax Reform Act of 1986. (H.R. 3838), U.S. Code Congressional and Administrative News, 1986-11, No. 9A, 879 p.
Google Scholar

PWC Portal, 2022, Poland. Taxes on corporate income https://taxsummaries.pwc.com/poland/corporate/taxes-on-corporate-income [Accessed 18.02.2022].
Google Scholar

Reschiwati R., Hasudungan H., 2020, Financial distress and tax motivation: the effect on earnings management. Dinasti International Journal of Economics, Finance & Accounting, 1(4), pp. 682–695 https://doi.org/10.38035/dijefa.v1i4.545
Google Scholar DOI: https://doi.org/10.38035/dijefa.v1i4.545

Roubi, R. R., Richardson, A. W., 1998, Managing discretionary accruals in response to reductions in corporate tax rates in Canada, Malaysia, and Singapore. The International Journal of Accounting, 33(4), pp. 455–467 https://doi.org/10.1016/S0020-7063(98)80004-6
Google Scholar DOI: https://doi.org/10.1016/S0020-7063(98)80004-6

Scholes M. S., Wilson G. P., Wolfson M. A., 1992, Firms' responses to anticipated reductions in tax rates: The Tax Reform Act of 1986 https://doi.org/10.2307/2491200
Google Scholar DOI: https://doi.org/10.3386/w4171

Simpson A., 2013, Does investor sentiment affect earnings management?. Journal of Business Finance & Accounting, 40(7-8), pp. 869–900 https://doi.org/10.1111/jbfa.12038
Google Scholar DOI: https://doi.org/10.1111/jbfa.12038

Sundvik D., 2016, Earnings management around Swedish corporate income tax reforms. International Journal of Accounting, Auditing and Performance Evaluation, 12(3), pp.261–286 https://doi.org/10.1504/IJAAPE.2016.077892
Google Scholar DOI: https://doi.org/10.1504/IJAAPE.2016.077892

Sundvik D., 2017a, A review of earnings management in private firms in response to tax rate changes. Nordic Tax Journal, 2017(1), pp. 151–161 https://doi.org/10.1515/ntaxj-2017-0011
Google Scholar DOI: https://doi.org/10.1515/ntaxj-2017-0011

Sundvik D., 2017b, Book-tax conformity and earnings management in response to tax rate cuts. Journal of International Accounting, Auditing, and Taxation, 28, pp.31–42 https://doi.org/10.1016/j.intaccaudtax.2016.12.003
Google Scholar DOI: https://doi.org/10.1016/j.intaccaudtax.2016.12.003

Suryarini T., Cahyaningrum, A. M., Hidayah, R., 2020, The Effect of Tunneling Incentive to Transfer Pricing Decision with Tax Minimization As a Moderating Variable. KnE Social Sciences, pp.1–13 https://doi.org/10.18502/kss.v4i6.6584
Google Scholar DOI: https://doi.org/10.18502/kss.v4i6.6584

Tang T. Y. H., 2015, Does book-tax conformity deter opportunistic book and tax reporting? An International Analysis. European Accounting Review, 24, pp. 441–469 https://doi.org/10.1080/09638180.2014.932297
Google Scholar DOI: https://doi.org/10.1080/09638180.2014.932297

Ugrin J. C., Mason, T. W., Emley, A., 2017, Culture's consequence: The relationship between income-increasing earnings management and IAS/IFRS adoption across cultures. Advances in accounting, 37, pp. 140–151 https://doi.org/10.1016/j.adiac.2017.04.004
Google Scholar DOI: https://doi.org/10.1016/j.adiac.2017.04.004

Wali K., 2021, The detection of earnings management through a decrease of corporate income tax. Future Business Journal, 7(1), pp. 1–12 https://doi.org/10.1186/s43093-021-00083-8
Google Scholar DOI: https://doi.org/10.1186/s43093-021-00083-8

Walker M., 2013, How far can we trust earnings numbers? What research tells us about earnings management. Accounting and Business Research, 43(4), pp.445–481 https://doi.org/10.1080/00014788.2013.785823
Google Scholar DOI: https://doi.org/10.1080/00014788.2013.785823

Watrin C., Ebert N., Thomsen M., 2012, One-book versus two-book system: Learnings from Europe. The Journal of the American Taxation Association, 36, pp. 55–89 https://doi.org/10.2139/ssrn.2001714
Google Scholar DOI: https://doi.org/10.2308/atax-50769

Watrin C., Pott C., & Ullmann R., 2012, The effects of book-tax conformity and tax accounting incentives on financial accounting: evidence from public and private limited companies in Germany. International Journal of Accounting, Auditing and Performance Evaluation, 8(3), pp.274–302.
Google Scholar DOI: https://doi.org/10.1504/IJAAPE.2012.047811

Wong R. M., Lo A. W., Firth M., 2015, Managing Discretionary Accruals and Book‐Tax Differences in Anticipation of Tax Rate Increases: Evidence from China. Journal of International Financial Management & Accounting, 26(2), pp. 188–222 https://doi.org/10.1111/jifm.12027
Google Scholar DOI: https://doi.org/10.1111/jifm.12027

Zang A. Y., 2012, Evidence on the trade-off between real activities manipulation and accrual-based earnings management. The accounting review, 87(2), pp. 675–703 https://doi.org/10.2308/accr-10196
Google Scholar DOI: https://doi.org/10.2308/accr-10196

Zeng T., 2014, Earnings management around tax rate reduction: evidence from China's 2007 corporate tax reform. Asian Review of Accounting https://doi.org/10.1108/ARA-01-2014-0012
Google Scholar DOI: https://doi.org/10.1108/ARA-01-2014-0012