Earnings Management, Corporate Tax Shelters, and Book-Tax Alignment

Abstract

This paper reviews recent evidence analyzing the link between earnings management and corporate tax avoidance and considers the implications for how policymakers should evaluate the financial reporting environment facing firms. A real-world tax shelter is dissected to illustrate how tax shelter products enable managers to manipulate reported earnings. A stylized example is developed that generalizes this view of corporate tax avoidance and empirical evidence consistent with this view is discussed. This view of corporate tax avoidance implies that shareholders and policymakers should question the rationale for distinct financial reports and that greater book-tax alignment may have mutually beneficial effects for investors and tax authorities.

Keywords: Earnings management, Tax avoidance, Tax shelters; Book-tax conformity

JEL Classification: G30, H25, H26, J33, M41, M43