How Much Will Firms Pay for Earnings that Do Not Exist? Evidence of Taxes Paid on Allegedly Fraudulent Earnings

Posted: 5 Nov 2003

See all articles by Merle Erickson

Merle Erickson

University of Chicago - Booth School of Business

Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Edward L. Maydew

University of North Carolina at Chapel Hill

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Abstract

We analyze a sample of firms accused of fraudulently overstating their earnings and examine the extent, if any, to which they paid additional income taxes on the allegedly fraudulent earnings. Based on restatements of current tax expense adjusted for the tax benefits of stock options, the evidence indicates that many firms included the overstated financial accounting income on their tax returns, thus overpaying their taxes in the process of inflating their accounting earnings. We estimate that the median firm sacrificed eight cents in additional income taxes per dollar of inflated pre-tax earnings. In aggregate, we estimate that the firms in our sample paid $320 million in taxes on overstated earnings of about $3.36 billion. These results indicate how far managers of firms are willing to go to when allegedly inflating earnings.

Keywords: Fraud, tax, earnings

JEL Classification: G30, G32, J33, M41, M43, H25

Suggested Citation

Erickson, Merle and Hanlon, Michelle and Maydew, Edward L., How Much Will Firms Pay for Earnings that Do Not Exist? Evidence of Taxes Paid on Allegedly Fraudulent Earnings. Accounting Review, April 2004. Available at SSRN: https://ssrn.com/abstract=463082

Merle Erickson (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
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Michelle Hanlon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Cambridge, MA 02142
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Edward L. Maydew

University of North Carolina at Chapel Hill ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-843-9356 (Phone)

HOME PAGE: http://www.kenan-flagler.unc.edu/faculty/directory/accounting/edward-maydew

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