Book-Tax Differences, a Proxy for Earnings Management and Tax Management - Empirical Evidence from China
36 Pages Posted: 30 Dec 2005 Last revised: 29 Sep 2016
This paper investigates the potential of book-tax differences (BTDs) for capturing opportunistic book and tax reporting in the Chinese context. It firstly constructs a conceptual framework interpreting BTDs as a function of accounting-tax misalignment, earnings and tax management. Next, this paper develops a cross-sectional regression model to identify normal and abnormal components in total BTDs. Normal BTDs refer to the mechanical differences due to divergent reporting rules for book and tax purposes, signaling the extent of accounting-tax misalignment. Alternatively, abnormal BTDs reflect the opportunistic differences due to managerial choices in accounting and tax reporting, quantifying the level of management manipulations.
Using unique tax-based BTDs data obtained from English-version financial reports of Chinese B-shares listed firms, this paper examines the association between abnormal BTDs and the incentives for earnings and tax management in China. The evidence shows that firms with strong incentives and prospects for earnings and tax management exhibit high levels of abnormal BTDs. The magnitude of abnormal BTDs appears to indicate the level of management manipulations, suggesting that BTDs are a useful proxy for combined earnings and tax management after controlling for accounting-tax misalignment.
Keywords: Book-tax differences, earnings management, tax management, China
JEL Classification: M41, M43, M47, H25
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