Book-Tax Conformity and Earnings Management in Response to Tax Rate Cuts

Abstract

This study explores the link between earnings management and jurisdictional differences in book-tax conformity. A dataset of national reforms where the corporate tax rate is lowered is used to estimate the effect of conformity on private firm’s earnings management behavior when a specific incentive to manage earnings downward exists. Total and discretionary accruals are used to measure earnings management and a continuous measure is used to assess the level of book-tax conformity. The results suggest that changes in the statutory tax rate affect firms within jurisdictions with high book-tax conformity more than firms in jurisdictions where book and taxable income are less conformed. However, more overall earnings management is attributed to firms in the low conformity jurisdictions. With these findings, a contribution based on private firms and signed earnings management is made to the ongoing debate on the appropriate level of book-tax conformity.

Keywords: earnings management, tax incentive, tax reform, private firms, book-tax conformity

JEL Classification: M41, H25, H26