The Impact of Earnings Management and Tax Planning on the Information Content of Earnings

SSRN Electronic Journal 11/2007; DOI: 10.2139/ssrn.1028808


This paper examines the effect of tax planning and earnings management on the relative informativeness of book income and taxable income. We conduct two sets of tests documenting (1) the incremental effect of tax planning and earnings management on the relative informativeness of book and taxable income and (2) the relation between voluntary conformity and the relative informativeness of book and taxable income. Based on these two sets of tests, we conclude that tax planning and earnings quality jointly affect the relative informativeness of book and taxable income.

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    • "Among others, studies investigating the effect of changes in accounting standards have found that earnings quality is significantly affected by the change indicated in value relevance models. For example, Cheng et al. (2007) examine whether the choice of accounting treatment of the transition obligation under SFAS106 affects firm value, and whether the quality of earnings is improved after the implementation of the standard. They found that although the total value relevance of both earnings and book value is not affected by the choices allowed under the new accounting standard, earnings quality under the immediate recognition method has been severely undermined by the one-time charge of the transition obligation. "
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    ABSTRACT: This paper reviews prior studies that provide an understanding of earnings quality concepts. It presents various definitions of earnings quality and discusses proxies used in empirical literature to measure earnings quality. Prior studies measure earnings quality by using time-series properties of earnings including earnings persistence, predictability, timeliness and volatility; relating accruals to future cash flows, associating earnings with stock market metrics such as stock prices and returns and assessing the level of discretionary accruals. The literature emphasizes that the quality of earnings is very important as the earnings figure is widely used in many contractual agreements and investing decisions.
    Full-text · Article · Aug 2014 · Procedia - Social and Behavioral Sciences
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    • "By comparing the ratios of the adjusted R 2 from an estimated taxable income regression to the adjusted R 2 from the book income regression for high tax planners and high earnings management firms, they find the estimated taxable income is less informative for tax aggressive firms but more informative for earnings management firms than is book income. Inconsistent with Ayers et al. (2009), Chen et al. (2007) find that the informativeness of taxable income is lower for firms that have higher discretionary accruals. The authors show that both earnings management and tax planning are negatively associated with stock returns and they attenuate the informativeness of earnings and taxable income. "
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    ABSTRACT: Prior studies document that book-tax differences (BTDs) reflect divergent reporting rules for book and tax purposes, and contain information about earnings management and tax planning. In this paper we investigate whether the regulatory and opportunistic information impounded in BTDs differentially influences earnings persistence and the earnings-returns relation. Using BTD data from China, we separate BTDs into normal BTDs (NBTDs) and abnormal BTDs (ABTDs). NBTDs are more likely driven by regulatory differences between accounting and tax rules and ABTDs are more likely driven by earnings and tax management activities. We find that firms with large positive and negative ABTDs (NBTDs) exhibit less earnings persistence compared to firms with small ABTDs (NBTDs). However, the level of earnings persistence for large unsigned ABTD firms is significantly lower than that for large unsigned NBTD firms. While large unsigned NBTDs appear to enhance the earnings-returns relation, we find no evidence that large unsigned ABTDs affect the earnings-returns relation. Overall, the results suggest that the differing components of BTDs have differential implications for earnings quality. Additional tests show that ABTDs and NBTDs can provide incremental information about earnings persistence beyond the information in discretionary accruals and total accruals, suggesting that the investigation of BTDs adds value to financial analysis.
    Full-text · Article · Sep 2012 · The International Journal of Accounting
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    • "We focus on cross-country differences in book-tax conformity because we are interested in the effects of required book-tax conformity (i.e., the extent to which managers are allowed to report accounting earnings that differ from taxable income). Studies that focus on book-tax differences within the U.S. (e.g., Hanlon, 2005; Chen, Dhaliwal and Trombley, 2007; Ayers, Jiang and Laplante, 2009) examine cross-sectional differences in managers " choices within a country where large differences between accounting earnings and taxable income are allowed. "
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    ABSTRACT: Calls for eliminating differences between accounting earnings and taxable income in the US have been debated extensively. Proponents of increased book-tax conformity argue that tax compliance will increase and earnings quality will improve. Opponents argue that earnings quality will decline. We examine whether the level of required book-tax conformity affects earnings persistence and the association between earnings and future cash flows. We develop a comprehensive book-tax conformity measure and find that earnings have lower persistence and a lower association with future cash flows when conformity is higher. Our evidence suggests that increased book-tax conformity may reduce earnings quality.
    Full-text · Article · May 2010 · Journal of Accounting and Economics
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