The impact of tax holidays on earnings management : an empirical study of corporate reporting behavior in a developing-economy framework

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Abstract

This study investigates whether foreign investment enterprises (FIEs) in China alter their corporate reporting behavior in response to a known schedule of tax-rate increases. The context of this investigation is a tax-incentive scheme that allows firms to pay taxes at a reduced rate for a limited period of time, and then at a higher rate when this period expires. If managers attempt to maximize firm value by minimizing tax costs, then the spread of tax rates in the periods surrounding the rate change may provide a substantial incentive for them to accelerate revenue and defer expenses. Consistent with this hypothesis, the empirical results indicate that firms report significantly higher discretionary current accruals for the years before tax-rate increases. The evidence, which indicates that firms manage earnings upward to take advantage of lower tax rates that are available in certain years, has important implications for tax policymakers.
Original languageEnglish
Pages (from-to)163-175
Number of pages13
JournalThe International Journal of Accounting
Volume41
Issue number2
DOIs
Publication statusPublished - 1 Jan 2006

Bibliographical note

I thank K. Hung Chan, Ian A. Fraser and William E. Shafer for their reviews of this paper, and Joe Zou, Phyllis L. Mo and Donghui Wu for their advice on certain issues. I am most grateful to Kevin Chen (the Editor) and one anonymous referee for their constructive comments and suggestions. My thanks also go to Rebecca Luo, Tang Feng, and Pauline Wong for their data collection and research assistance. Financial support from Lingnan University is also acknowledged.

Keywords

  • Discretionary accruals; Earnings management; Foreign investment enterprises (FIEs); Income shifting; Tax holidays

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