Tax Planning and Managers’ Preference for Smooth Earnings
Posted: 14 Feb 2013
Date Written: February 13, 2013
Recent survey evidence suggests that a majority of financial executives have a preference for smooth earnings streams and are willing to sacrifice long-term value to smooth earnings. While prior research provides mixed evidence of the benefits of smooth earnings, there has been little attention on the tradeoff between managers’ preference for smooth earnings and value-enhancing activities that induce earnings volatility. We address this void in the literature by investigating the link between managers’ preference for smooth earnings and tax planning, an activity that both enhances firm value and increases earnings volatility. Consistent with managers that have a preference for smooth earnings engaging in less tax planning, we find an economically significant relation between both the effective tax rate and cash effective tax rate and the preference for smooth earnings. Additional evidence suggests that managers that have a stronger preference for smooth earnings are less likely to engage in aggressive tax strategies. These results are consistent with the preference for smooth earnings impacting not only the level but also the nature of foregone value-enhancing activities.
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