The Association between Book-Tax Conformity and Earnings Management

Abstract

There is an on-going debate in the literature about the costs and benefits of conforming book and taxable income. Proponents argue that increased book-tax conformity will reduce aggressive financial reporting because managing earnings up increases taxes and will curtail abusive tax shelters because managing taxes down decreases earnings reported to shareholders. We use a panel of 139,536 firm-year observations across 34 countries over the period 1996-2007 to test whether high levels of book-tax conformity are associated with less earnings management and find that higher book-tax conformity is associated with significantly more, not less earnings management. We conclude that one of the primary claimed benefits of increasing book-tax conformity, more truthful financial reporting with less earnings management, is unlikely to be as large as previously thought.

Keywords: book-tax conformity, earnings management

JEL Classification: H20, H25, M41