Book-tax Conformity Research Articles

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

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.

Transparency, Tax Pressure, and Access to Finance *

More transparent firms enjoy better access to finance, and also enable closer scrutiny by tax authorities and thus face a heavier tax burden, insofar as they are required to report the same data to tax authorities and investors (book-tax conformity). We study this trade-off in a model with distortionary taxes and finance rationing, and test its predictions on an international dataset. As predicted, firms facing low corporate tax rates choose high transparency, particularly if they are not very dependent on external funding. This result is confirmed by the evidence from statutory tax reforms: reductions of corporate tax rates are followed by increases in firm transparency. Moreover, firms choose higher transparency in countries with high audit quality. Investment is positively correlated with transparency, especially for firms more dependent on external finance. Results are stronger in countries with book-tax conformity.

Country-by-Country Reporting: A New Approach towards Book-Tax Conformity

In this article, the author argues that increased book-tax conformity can be achieved through improved documentation, in particular in the field of transfer pricing, and through country-by-country reporting.

Earnings Restatements and Characteristics of Corporate Executives: Evidence from Japan

In Japan, financial statements are disclosed under the timely disclosure regulations of securities exchanges before the completion of an external audit and disclosed again after the completion of an external audit under the Financial Instruments and Exchange Act. In each case, any errors contained in financial statements have to be corrected. This study investigated how the characteristics of corporate executives might affect the occurrence probability of earnings restatements. I found that the appointment of a CFO who is a certified public accountant or the presence of a former accounting chief of the company concerned (or another company) among the auditors reduce the occurrence probability of earnings restatements occurring before (or after) the completion of an audit as a result of unintentional errors. In contrast, if the auditors include a certified tax accountant with experience in tax collection, the probability of earnings restatements increases regardless of whether an audit has been completed. This suggests that strong tax saving incentives on the side of companies affect financial reporting given that book-tax conformity is high in Japan.

R&D Intensity and the Effective Tax Rate - A Meta-Study

We apply meta-regression techniques to provide a quantitative review of the empirical literature on how research and development (R&D) expenses affect the effective tax rate (ETR). R&D expenses relate to a well-accepted profit shifting channel, strategic placement of intellectual property within a multinational entity. Using a unique hand-collected data set, we add a new perspective to the current base erosion and profit shifting (BEPS) state of research and debate, in three ways: First, observing that primary studies report mixed evidence on how R&D expenses affect ETR, we provide a consensus estimate for this effect. Second, we consider this effect in more detail by separating a tax accounting effect and a profit shifting effect, which to our knowledge has not yet been investigated. We detect that one-third of the R&D effect on the ETR is due to the tax accounting effect and could be mitigated via book-tax conformity. We further find that 10% of the profit shifting effect can be traced back to R&D tax credits. Third, our meta-regression reveals factors that are possible sources of variation and bias in previous empirical studies.

A Study on the Book-Tax Conformity for the Adoption of K-IFRS and Its Implications for Corporate Income Tax Law

A Study on the Book-Tax Conformity for the Adoption of K-IFRS and Its Implications for Corporate Income Tax Law

DISCUSSION OF Book-Tax Conformity and Earnings Management: Insights from European One- and Two-Book Systems

W atrin, Ebert, and Thomsen (2012; hereinafter, WET) examine the influence of financial and tax reporting requirements on earnings management by European firms. WET explain two reporting requirements imposed on European firms that differ from those placed on U.S. firms. First, parent and subsidiary corporations are required to file tax statements on a separate-company basis rather than on a consolidated-group basis and, second, corporations are required to disclose separate-company financial statements as well as consolidated-group financial statements. Using these two unique aspects of European reporting, WET investigate how discretionary accruals in the consolidated-group financial statements are related to the magnitude of book-tax differences in separate-company financial statements and to the use of IFRS versus local GAAP accounting standards in the separate-company financial statements. WET conclude that firms operating in a one-book system (where corporations use IFRS for consolidated-group financial statements, separate-company financial statements, and tax reporting) show significantly more earnings management in consolidated financial statements compared with those in a two-book system (where corporations use IFRS for consolidated-group financial statements but use local GAAP for separate-company financial statements and for tax reporting). They further conclude that conformity between separate-company financial statements and tax reporting shows a stronger association with earnings management in consolidated financial statements than does the accounting standard used in the separate-company financial reports. Generally, book-tax conformity and book-tax differences are measured based on differences between the earnings a firm reports to its investors (in consolidated-group financial statements) and the income it reports to tax authorities. WET add to the existing literature by focusing on permanent book-tax differences in separate-company financial statements and the accounting standards used in separate-company versus consolidated-group financial statements. Examining earnings management in this rich institutional setting is the primary strength of this study. My questions and concerns about this study relate to (1) the choice between IFRS and local GAAP, (2) the tax filing

Political Uncertainty and Corporate Tax Avoidance: Evidence from National Elections around the World

We empirically investigate the effects of political uncertainty on corporate tax behavior. To identify the effects of political uncertainty, we construct a data set that tracks whether firms’ tax avoidance varies systematically around the occurrence of national elections. Our dataset includes firms exposed to 103 national elections in 30 countries. We find that corporate tax avoidance varies systematically across the election cycle, peaking in election years and declining the next year. The effect on tax avoidance is greatest for elections with greater electoral uncertainty, and for elections in countries with relatively lower quality of law, relatively weaker tax enforcement, and relatively lower book-tax conformity. The evidence suggests that firms use both conforming and nonconforming tax avoidance strategies, although the results for conforming tax avoidance are marginal.

Does Book-Tax Conformity Deter Opportunistic Book and Tax Reporting? An International Analysis

This paper examines whether book-tax conformity (i.e. reducing the gap between financial and taxable incomes) can restrain managers from opportunistically reporting financial profits and taxable income. Empirical work on this relation so far is limited and provides contradictory results. Using publicly available financial statements from 1994 to 2007 for 16,739 firms across 32 countries, I construct a new proxy for mandatory conformity and document that high book-tax conformity is associated with lower levels of earnings management and tax avoidance. These results persist even after controlling for firm characteristics and institutional factors, such as legal enforcement, investor protection, legal systems, capital market development, and the adoption of International Financial Reporting Standards (IFRS). Additional tests reveal that the deterrent effect of conformity on earnings management is more pronounced in code-law countries but does not differ between IFRS and non-IFRS adopters, and between developed and developing capital markets.

Book-Tax Conformity and Capital Structure

We examine the effect of increased book-tax conformity on corporate capital structure. Prior studies document a decrease in the informativeness of accounting earnings for equity markets resulting from higher book-tax conformity. We argue that the decrease in earnings informativeness impacts equity holders more than debt holders because of the differences in payoff structures between debt and equity investments such that increases in book-tax conformity lead to increases in firms’ reliance on debt capital. We exploit a natural experiment in the U.S. and find that firms facing an increase in required book-tax conformity increase leverage relative to other firms. We also provide evidence of an increase in the cost of equity (but not of debt) capital for firms facing an increase in required book-tax conformity relative to control firms and that these increases in cost of equity capital are positively associated with an increase in leverage. Our findings are consistent with firms substituting away from equity and towards more debt in the presence of higher book-tax conformity.

The association between book-tax conformity and earnings management

There is an ongoing debate in the literature about the costs and benefits of conforming book and taxable income. Proponents argue that increased book-tax conformity will reduce aggressive financial reporting: managing earnings up increases taxes and will curtail abusive tax shelters because managing taxes down decreases earnings reported to shareholders. We use a panel of 139,536 firm-year observations across 34 countries over the period 1996–2007 to test whether high levels of book-tax conformity are associated with less earnings management. We find that higher book-tax conformity is associated with significantly more, not less, earnings management. We conclude that one of the primary claimed benefits of increasing book-tax conformity, more truthful financial reporting with less earnings management, is unlikely to be as large as previously thought.

The Effect Of Book-Tax Conformity On The Use Of Accruals: Evidence From Korea

<p>This study in the Korean context investigates the effect of book-tax conformity on the use of accruals. In a sample of 4,331 Korean firms, we divide total accruals into book-tax accruals and book-only accruals. Book-tax accruals are defined as those that affect both taxable income and reported earnings. Book-only accruals are defined as those that affect only reported earnings and are unrelated to taxable income. We anticipate that managers will decrease taxable income by recording book-tax accruals that conform relatively closely to taxable income in order to reduce their tax liability. They are expected to attempt to increase book income through book-only accruals. We also examine the market response to firms that use these two types of accruals in different ways. Our evidence demonstrates increased use of income-decreasing book-tax accruals to decrease taxable income and increased use of book-only accruals to increase financial income. Use of book-only accruals also compensates for potential costs unrelated to tax, such as financial reporting costs. In addition, our results show that the market correctly assesses the management of accruals even when the uses of book-tax and book-only accruals offset each other.</p>

Book-Tax Conformity and Earnings Management: Insights from European One- and Two-Book Systems

ABSTRACT:There is an ongoing debate in the U.S. about the effect of book-tax conformity on earnings management in consolidated statements. Although both one- and two-book systems are present in Europe, European data have not been used to contribute to this debate. In this study, we examine the influence of one- and two-book systems on earnings management using consolidated statements and single financial statements of European firm-years from 2004 to 2011. A one-book system is defined as a situation in which financial accounting income and taxable income are highly conformed, whereas a two-book system is characterized by differences between consolidated financial income and taxable income. We find that firms in one-book systems show significantly more (downward) earnings management in their consolidated statements than do firms in two-book systems. With these findings, we contribute to the U.S. policy debate on book-tax conformity and earnings management.

The Development of Book-Tax Differences in Seven Major Countries

This paper proposes an indicator of book-tax difference, based on the sum of the absolute amounts of permanent and timing differences. Using this, we first trace the development of book-tax differences over 18 years in seven major countries. We show that the indicator has grown almost monotonically in all the countries, and that the ranking of countries has been stable. Our research questions are: what causes the international variation in book-tax differences, and how and why do the differences change over time? To address these, we regress our indicator on a number of accounting items. We find that several items associated with book-tax conformity are highly significant causes of book-tax differences, which leads us to believe that our indicator can serve as a quantitative measure of book-tax conformity. To explain the causes of variation over time, we compare the results of three six-year periods, enabling an assessment of the effect of IFRS from 2005.

The Relationship Between the Management of Book Income and Taxable Income Under a Moderate Level of Book-Tax Conformity

We find evidence suggesting that taxable income management is not related to book income management in firms operating under a moderate level of book-tax conformity. For a sample of Israeli firms that the tax authorities determined had understated their earnings to avoid taxes, we do not find evidence of an overstatement of book earnings. Notably, public firms do not differ from private firms in this regard. Using a control sample of firms that were not subject to tax audits, we validate that self-selection does not affect our inferences. Given Israel’s unique “intermediate” level of book-tax conformity, an important practical contribution of the findings is in shedding more light on the question of the need for a substantial transition from nonconformity to full alignment in countries with large book-tax gaps (such as the United States). Our results showing that tax-avoiding firms in Israel, public and private alike, avoid book income management even if areas of book-tax nonconformity allow them to do so imply that a reduction in the divergence between the tax and the accounting rules may suffice to reduce managers’ opportunistic (reporting) behavior.

Management Of Accrual Components In Response To Corporate Income Tax Rate Changes: Evidence From Korea

Changes in the statutory corporate income tax rate provide firms with an opportunity to reduce their tax burden by shifting their taxable income from higher to lower tax rate years. One negative consequence of shifting taxable income across years is higher variation in book income for financial reporting purposes. Taxable income and book income are closely related in most countries, and, in general, reporting volatile book income across years is not a favorable signal to investors. This study investigates how firms shift taxable income and concurrently mitigate book income fluctuation by managing accrual components separately when the statutory income tax rate changes. Unlike prior studies, we decompose discretionary accruals into two components and examine distinctive patterns of accrual management in Korea, where book-tax conformity is high and aggressive tax avoidance is restricted. We find that firms manage book-tax accruals for taxable income shifting and manage book-only accruals to mitigate book income fluctuation. Furthermore, we find the extent of book-tax and book-only accruals management varies depending on the firms tax and financial reporting costs. The results of this study provide clear and compelling evidence of firms opportunistic accrual management behavior in response to statutory tax rate reduction.

Effects of IFRS Adoption on Tax-induced Incentives for Financial Earnings Management: Evidence from Greece

We investigate whether the adoption of International Financial Reporting Standards (IFRS) in Greece affected tax-induced incentives for financial earnings management. Prior to the implementation of IFRS, there were powerful incentives for firms facing higher tax pressure to restrict (exacerbate) upward (downward) financial earnings management due to direct tax implications. IFRS adoption reduced book–tax conformity, thereby releasing financial income from tax implications. As expected, we find that tax pressure is a significant negative determinant of discretionary accruals in the pre-IFRS period. However, this effect dissipates under the new IFRS regime.

Book Reviews

Book Reviews

Tax Effects of Book-Tax Conformity, Financial Reporting Incentives, and Firm Size

ABSTRACTThis study employs a natural experiment to examine the tax effects of a change in the level of conformity between tax and financial reporting in China for firms with different financial reporting incentives. We find that in a full book-tax conformity system, firms with incentives to report higher book income pay significantly higher income tax (per dollar of sales) than do firms without the same incentives. Although we do not find similar evidence in a non-conformed system, we observe cross-sectional variation in taxes paid by firms of varying sizes: by exploiting non-conforming financial reporting rules to a greater extent, large firms pay proportionately lower taxes than do small firms. To improve financial reporting quality, many countries have adopted International Financial Reporting Standards (IFRS) that may affect book-tax reporting differences. Our results suggest that this policy alternative is less desirable from a tax perspective. Therefore, accounting standard setters and securities regulators around the world should consider not only how such a change is intended to benefit capital markets, but also what unintended consequences this policy choice might have for government revenue. Our results also strengthen the government policy position on giving more tax relief to small firms.Data Availability: All data are available from public sources.

One-Book Versus Two-Book System: Learnings from Europe

Despite ongoing debates about the effect of book-tax conformity on earnings management in consolidated statements, there is a paucity of evidence from Europe, where both one- and two-book systems occur. In this study, we examine the influence of one- and two-book systems on earnings management using the consolidated statements of 18,578 European firm-years from 2004 to 2009. We find that firms in a one-book system show significantly more earnings management in consolidated statements compared with those in a two-book system.