The Effect of Book-Tax Conformity on Earnings Persistence: New Evidence

Abstract

This paper contributes to the ongoing book-tax conformity debate by examining whether conformity (i.e., reducing the gap between book and tax accounting) improves earnings reliability by restraining managers from reporting financial profits and taxable income aggressively. Using financial statement information from 1994 to 2004 for 18,027 firms from 33 countries, I investigate whether the level of mandatory book-tax is associated with the degree of earnings management and tax planning in a cross-country setting. I construct a new book-tax conformity measure and examine the ex post impact of conformity on earnings persistence. The findings reveal that, after controlling for institutional factors and firm characteristics, firms in countries with a high level of book-tax conformity exhibit a low level of earnings management and tax avoidance. Consistent with the proposed benefits claimed by the proponents, book-tax conformity enhances earnings persistence by curbing opportunistic book and tax reporting that impairs the creditability of reported earnings.