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Earnings Management Strategies and the Trade-Off Between Tax Benefits and Detection Risk: To Conform or not to Conform?

Posted: 18 Oct 2008  

Brad A. Badertscher

University of Notre Dame

John D. Phillips

University of Connecticut - Department of Accounting

Morton Pincus

University of California, Irvine

Sonja O. Rego

Indiana University - Kelley School of Business - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: June 24, 2008

Abstract

Prior research has separately examined pretax earnings management activities that have current taxable income consequences (book-tax 'conforming earnings management') and those that do not have current taxable income consequences (book-tax 'nonconforming earnings management'). Our study documents the prevalence of, and then investigates the firm-specific characteristics that impact the choice between, these earnings management strategies. We utilize a sample of firms that restated their earnings downward due to accounting irregularities and thus can be presumed to have managed earnings upward. We find that nonconforming earnings management is more prevalent and that firms trade off the net present value of tax benefits against the net expected detection costs associated with nonconforming earnings management. In particular, firms having NOL carryforwards, using a high quality auditor, or engaging in the most egregious misstatements rely less on nonconforming earnings management strategies. We also find that book-tax differences are useful in predicting restatements.

Keywords: earnings management, earnings restatements, book-tax differences, deferred tax expense, current tax expense

JEL Classification: M41, M43, M49, H25, G38

Suggested Citation

Badertscher, Brad A. and Phillips, John D. and Pincus, Morton and Rego, Sonja O., Earnings Management Strategies and the Trade-Off Between Tax Benefits and Detection Risk: To Conform or not to Conform? (June 24, 2008). Accounting Review, 2009. Available at SSRN: https://ssrn.com/abstract=1286238

Brad Badertscher

University of Notre Dame ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

John Phillips

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States
860-486-2789 (Phone)
860-486-4838 (Fax)

Morton Pincus

University of California, Irvine ( email )

Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)

Sonja Rego (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812 855-6356 (Phone)

HOME PAGE: http://kelley.iu.edu/Accounting/faculty/page12887.cfm?ID=33017

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