This paper investigates how firms manage their earnings to trade off various incentives when tax rates increase. We hypothesize and find that firms generally choose to manage their taxable income upward in a book-tax non-conforming manner rather than in a book-tax conforming manner before a tax rate increment, which in turn reduces the detection risk of aggressive financial reporting. These results suggest that firms give more weight to tax incentives and tax audit or regulatory inspection risks than to boosting financial reporting income in tax management. However, when firms have higher book management incentives or lower tunneling incentives (i.e., non-state-owned enterprises), we find that they manage their taxable income and book income upward together (i.e., in a book-tax conforming manner), whereas their counterparts (i.e., state-owned enterprises) do not. Overall, our paper contributes to the literature by demonstrating the interplay of tax, tunneling and financial reporting incentives in influencing tax management strategies. The findings from our paper should also help government and regulators understand more about firms’ reactions to tax rate increases.
|Number of pages||35|
|Journal||Journal of International Financial Management and Accounting|
|Early online date||7 Apr 2015|
|Publication status||Published - Jun 2015|
Bibliographical noteThis research has benefited from financial support from Lingnan University, Hong Kong (DB14A5). Michael Firth acknowledges financial support from a GRF (GRF390113). Raymond Wong (corresponding author) acknowledges the financial support of grants from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. CityU 152012 and 195513).
WONG, R. M. K., LO, W. Y. A., & FIRTH, M. A. (2015). Managing discretionary accruals and book-tax differences in anticipation of tax rate increases : evidence from China. Journal of International Financial Management and Accounting, 26(2), 188-222. https://doi.org/10.1111/jifm.12027