Political Connections and Tax-Induced Earnings Management: Evidence from China

Abstract

We use the occasion of a change in tax policy that raised the tax rate for many of the listed companies in China to examine tax-induced earnings management (TEM) from the perspective of political connections. We find that when the tax rate increased, only those affected firms with politically connected management engaged in TEM. This suggests that, in addition to motivation for managing earnings, capability of influencing tax authorities is also an important determinant of TEM. We also find that TEM helped the firms with politically connected management to reduce their tax burden.

Keywords: China; earnings management; effective tax rate; political connections; tax policy

JEL Classification: G32; G38; H26; M41