Listed companies’ income tax planning and earnings management: Based on China’s capital market
Abstract: The Ministry of
Finance issued the new China accounting standards on February 15,
2006(CAS2006), which require the listed companies to use the balance sheet
liability method for the income tax accounting. Thus, it give us an opportunity
to investigate the earnings management of listed companies from the perspective
of income tax. Under the balance sheet liability method, because conforming
earnings management strategies and nonconforming earnings management strategies
have different income tax cost and the current income payable will also vary,
the listed companies need to choose conforming earnings management and
nonconforming earnings management. Our research just try to investigate the
relationship between the listed companies’ income tax planning and earnings
management on the background of this new system.
Design/methodology/approach: Our research approach combines theoretical
analysis and empirical analysis. This paper first make a deep theoretical
analysis on the listed companies’ choice between pretax earnings management
activities that have current income tax consequences (book-tax ‘conforming
earnings management’) and earnings management activities that do not have
current income tax consequences (book-tax ‘nonconforming earnings
management’),and then we exemplify our theory. Next, we come up with two hypotheses
based on the theoretical analysis, build up a restatement model and conduct the
empirical examination. The empirical analysis employs the method of descriptive
statistics and logistic regression.
Findings: When engaging in earnings management, listed companies will
trade off conforming and nonconforming earnings management from the perspective
of income tax cost. We find that managers’ motivations and purposes will
influence the choice. On the one hand, when companies are facing the punishment
of the suspension or termination of the listing for three consecutive losses,
they will have a great incentive to manage earnings in order to turn losses
into gains. In this case, companies can’t wait to manage earnings to increase
incomes and won’t consider income tax cost too much. And if they employ
nonconforming earnings management bringing greater book-tax differences, it may
increase the probability of being detected and earnings management behavior may
also be found. Thus, in this motivation, listed companies will employ more
conforming earnings management. On the other hand, when companies engage in
fraudulent activities, they will avoid the use of earnings management
strategies which bringing greater book-tax difference to avoid penalty cost
associating with fraud being found, since greater book-tax difference will
possibly attract regulatory agencies’ and auditors’ attention therefore lead to
the fraud being found. In this motivation, listed companies will employ more
conforming earnings management. In summary, the main conclusion is when the
company has motivations to turn losses into gains and has the motivation to
avoid penalty cost associated with fraud being found, the company prefers to
employ more conforming earnings management strategies.
Research limitations/implications: The limitation in our research is as
follows. First, we mainly focus on the conforming and nonconforming earnings
management when the listed companies restate their financial statements.
However after the issue of CAS2006, many listed companies still not disclose
income tax account, which restrict our sample. Second, without the acquisition
of private companies’ data, our empirical results may have some errors. We will
solve these problems in our future study.
Practical/social implications: Based on the sample of restatement
companies, our research explores the listed companies’ choice of conforming and
nonconforming earnings management under different motivations, which provides
our study with new perspective and theoretical evidence. Meanwhile, because
this paper focuses on restate firms’ earnings management, the results are
helpful for regulators to strengthen the administration of listed companies’
restatement, as well as decrease the damage of restatement on our capital market.
Finally, our results indicate that when the company has motivations to turn
losses into gains and has motivations to avoid penalty cost associated with
fraud being found, the company prefers to employ more conforming earnings
management strategies. It will help us to deeply understand the impact of the
accounting processes of income tax under the balance sheet liability method on
the listed companies, therefore provide companies’ income tax planning with
essential empirical and theoretical evidences.
Originality/value: So far, earnings management researches in academia
mostly focus on the cost, motivations, means and results of earnings
management, there are few studies discuss the choice of earnings management
strategies and how different purposes and motivations affect the choice from
the perspective of income tax. The issue of CAS2006 offers an opportunity for
this research. This paper use restatement as sample to investigate the choice
of conforming earnings management and nonconforming earnings management under
different motivations and purposes for the first time. And not only study the
effect that earnings management have on income tax, but also study the effect
of different earnings management motivations on the choice of earnings
management strategies.
Author: Nanwei Hu, Qiang Cao,
Lulu Zheng
Journal Code: jptindustrigg150030
