The effect of financial factors on firms’ financial and tax reporting decisions

Abstract

Purpose – The purpose of this paper is to investigate the effect of financial factors on firms’ financial and tax reporting decisions. Firms often face the difficulties of accomplishing both financial and reporting goals. The extent to which reporting they put more value depends on the differential weighting of firms’ financial reporting and tax costs. The authors incorporate various financial factors as a source of cross-sectional differences in the weighing of both financial reporting and tax costs. Design/methodology/approach – To examine firms’ decisions when fulfilling both the purposes of financial and tax reporting is difficult, the authors use a large set of firms in Korea, where book-tax conformity is high and aggressive tax shelters are restricted. The authors develop a new measure that can specify firms’ decision making between financial and tax reporting by considering both earnings management and tax avoidance. Findings – The findings show that debt ratio affects firms’ financial and tax reporting decisions non-monotonically depending on the level of the debt ratio. The authors also find that firms with more long-term debt financing are more likely to be aggressive in financial reporting, while firms with higher financing deficit or better access to the capital market are more likely to be aggressive in tax reporting. Research limitations/implications – Thus, the findings provide more compelling evidence of firms’ decision making between two conflicting strategies, particularly when fulfilling both the purposes of financial and tax reporting is difficult. The authors expect that the results provide practical implications to standard setters, auditors and financial statement users who are interested in the ongoing debate over book-tax tradeoffs. Originality/value – This paper fulfills an identified need to study how firms’ decision making between two conflicting reporting strategies are affected by the various financial factors, which are closely linked to a firm’s financial reporting and tax costs.