Book-tax Differences, Earnings Management And Market Reaction

Since the pioneering research by Modigliani & Miller (1958,1963),the research in the impaction of corporate income tax on company's capital structure,dividend distribution, and other aspects of financial policy choices in West have been more perfect.From the view of accounting , the corporate income tax and corporate accounting are related and intertwined closely.Although,there have been some literatures in which tax impacts accounting policy choices in recent years,the research is on a more fragmented way.No study has analyzed the topic of Book-tax difference and the issue of earnings management under the background of Book-tax difference systematicly.With China's accounting standards reform pushing forward steadily,enterprises have had more choices of accounting policies and accounting estimate , the space of autonomy of earnings management is increasing gradually.Accordingly, the determinants of Book-tax difference and the economic consequences of Book-tax difference become more complex and changeable.In China, there have been sporadic introductions about this topic in recent years,but I have not found systematic and in-depth study.At the same time,In China,the discussion of Book-tax difference just remains in qualitative comparison between the terms of two systems,few literature conducted quantitative study on Book-taxable earnings difference and its determinants,nobody did empirical study about the behaviors of earnings management under the background of Book-tax difference,whether the signal function of accounting earnings to the stock market is affected,and whether the taxable earnings has valuating function.In view of this,I chose Book-taxable earnings difference for the cut point,use empirical research method to analyze listed companies in China,try to open the complex Laokai relationship between accounting and corparate income tax,and explore systematicly and in depth the earnings management in that context,as well as the response done by the capital market for such earnings management behavior.On the one hand,I strive to make some breakthroughs in research methods and in theory ,and analyze systematicly this problem in China.I believe my job could not only make up for the deficiencies of that field, but also want to intruduce related literature in west to Chinese readers.I believe what I done would be full of theoretical and practical significance.The paper is discussed mainly in five aspects:(1)the analysis basis about Book-tax difference and related earnings management;(2)the Empirical Research about determinants of Book-taxable earnings difference;(3) the Empirical Study about earnings management in dealing with the income tax system reform;(4)the Empirical Research about Book-taxable earnings difference and income tax cost of earnings management;(5)the Empirical Research about the recation of market to earnings management using Book-tax difference.As a whole,The paper started logically with Book-taxable earnings difference,the mainstrain in following research is the earnings management behavior and the related response from capital market.Through empirical testing,we found mainly conclusions as following:1.Book-taxable earnings difference and its determinantsComparing to the situation which book earnings of American Enterprise recently be consistently higher than taxable earnings,I found A-share listed companies in China,whose taxable earnings is consistently higher than book earnings.My empirical testing has found factors which affect Book-taxable earnings difference of Chinese A-share listed companies each year during 1999-2006.From the system and behavior,a number of factors would lead to the book-taxable earnings difference of Chinese listed companies,but we could see that 11 explanative variables or even less in the model have good interpretation on Book-taxable earnings difference.In particular:(1)The average annual investment returns and Book-taxable earnings difference is significantly positive correlative;(2)Exepect the year 2001 and 2003, the relationship between provision for impairment of assets and Book-taxable earnings difference is significantly negative correlative in other 6 years;(3)Apart from the year 1999 and 2001,the corporate income tax rate implemented and Book-taxable earnings difference is significantly positive correlative in other 6 years;(4)In the year 1999,2002,2004,2005 and 2006, the relationship between the depreciation of fixed assets and Book-taxable earnings difference is significantly positive correlative;(5) During 2002-2006,financial expenses and Book-taxable earnings difference is significantly negative correlative each year;(6)During 2002-2004,subsidies and Book-taxable earnings difference is significantly positive correlative each year;(7)In 1999 or 2005,the relationship between amortization of intangible assets or other long-term assets and Book-taxable earnings difference is significantly negative correlative;(8)The variable capital surplus and Book-taxable earnings difference is significantly negative correlative in 2002.2. Experience evidences that Book-tax difference being used for earnings managementFrom above conclusions, we can see there are many factors which lead to Book-taxable earnings divergence of Chinese listed companies,and in different years,the situation changes at different levels,but all the factors can be classified as tax increases type and tax reduction type. Corresponding to this, there are two directions of earnings management,one is to increase earnings,the other is reduce to earnings.Thus,on a fiscal year,both of directions of earnings management may be related with Book-tax difference. Follow that logical thought,we would explore two questions in following studies:Firstly,the relationship between managing earnings using Book-tax difference to reduce profits by enterprises and Book-tax difference;secondly, the relationship between managing earnings using Book-tax difference to increase profits and Book-tax difference.Through the empirical tests,I found those two aspects of empirical evidences for Chinese A-share listed companies.(1) The management of enterprise lobbiying for the GAAP and other laws which may affect accounting report,belongs to the studies of earnings management.China launched officially the mergering of demestic-funded corporate earning tax and foreign-funded corporate earning tax in 2006.The key change of institution is re-setting of the statutory tax rate. Through empirical analysis, I can see that there were indeed behaviors of earnings management,which were targeted to use Book-tax difference to reduce earnings for Chinese listed companies in 2005. By the way of improving the actual tax rate,it could affect the country,to achieve the purpose of lowering the statutory tax rate.The result is as same as that were from the United States.That is, to influence the government to reduce the statutory tax rate, the large-scale enterprises would manage accounting earnings so as to reduce income tax cost in the future.Our results show that,apart from that in the United States,there were positive related phenomena between ETR and using Book-tax difference to conduct earnings management of reducing profits for Chinese enterprises.(2)When the management of company is increasing earnings, it may face a sitution of weighing the costs of financial report and tax costs.To extricate from the predicament,the company could make full use of the differences between the tax laws and the accounting system.Through the manipulation of Book-taxable earnings difference,it could evade tax costs of earnings management.By examining the operating accruals of China's A-share listing company during 1999～2006,we confirmed the conclusion universal.Analysis showed that of listed companies,the greater be the earnings management,the bigger Book-taxable earnings difference would be.That is,listed companies have the motive to evade tax costs of earnings management through controling two-calibre earnings.On average,if listed company increase artificially operating accruals by 100 yuan in year 2005,2002 and 2004,there were 21,13 and 10 yuan earnings could avoid paying income tax expense respectively.The same sitution were only 5,6,5 and 4 yuan in year 2000,2001,2003,2004 and 2006 respectively.Clearly,from the point of maximizing the shareholder's wealth,such behavior of earnings management has some direct effect.But it also shows that the direct effect is relatively limited when companies used Book-taxable earnings difference to manage earnings.In fact,the listed companies have to pay tax for those non-existent profits still.The study also found that listed companies,with the increase of the tax rate,in order to save more tax cost, have more incentives to use projects of taxable-reducing earnings to change operating taxable earnings artificially.3.Market reaction to earnings management by using Book-tax differenceIn order to achieve the purpose of earnings management, the rational company would make full use of Book-tax difference.When the market is aware of that practices of manipulation,it may remain vigilant against the net accounting-earning in valuating stock,and would pay more attention to the net accounting-earning.Through empirical testing,the paper have confirmed this conjecture effectively.First of all,based on the information concept for the information content of accounting earnings,I tested the stock price reacted to the net accounting-earning and the taxable-earning in models of single explanatory variable respectively.The research found that the net accounting-earning and the taxable-earning of A-share listed companies in China were value-correlated respectively.We also found that,each year during 1999～2003,the information content of the net accounting-earning was higher than the taxable-earning for samples.But the situation reversed in the period 2004～2006,the information content of the taxable-earning was higher than that of the net accounting-earning.After putting EPS and (taxable-earning per share minus EPS) in the same model respectively,found that these explanatory variables are highly correlated with the stock price respectively.Comparative analysis also found that,the taxable earnings had privided incremental information to stock valuation for investors on the basis of the accounting earnings.Secondly,based on the concept of valuation for the information content of accounting earnings,we defined share price as the dependent variable,and defined EPS and net assets per share as the explanatory variables in building model.Through testing,we found that EPS and net assets per share of A-share listed companies in China were significantly positively related with share price in most of years during the inspection.The result show that not only the net accounting earnings but also the net assets could transfer decision-making relevant information to investors. After EPS was replaced by taxable earnings per share,the study found that the majority of years during the inspection taxable earnings and net assets of A-share listed companies in China were positive correlated significantly with share price at the same time.It indicates that both can transfer decision-making relevant information to investors.In addition,the examinations showed that investors' habits in stock valuating changed a lot began with the year 2004.The valuation model included taxable earnings per share and net assets per share was superior to the valuation model included EPS and net assets per share.It shows that taxable earnings per share plays a more visible role than net asset in the process of valuating stock by the market.At the same time ,it not only proved what we have modified about the model of Collins et al (1997) and the model of LuYufeng (1999) with taxable earnings per share instead of EPS is correct,but also such corrective measures have obtained good results.Our empirical analysis have found that rational management would make full use of Book-tax differences to manage earnings.And,the users of accounting statements from the capital market no longer use accounting data mechanically,they would adjust the accounting data.What the paper concerned is not for Book-tax differences itself only,but worried about corporate to conduct misunderstanding or fraud when they report taxable earnings or Book-earning which would result in the loss of efficiency by distorting such differences.Book-tax differences has become a reality,and would lead to some negative consequences.Against the status quo, we should not be doing nothing alone,but should consider actively the attitude of treating such differences.The current policy in China requires only listed companies to disclose income tax expense, does not require the disclosure of taxable earnings.Through the above analysis, we can see that the estimated taxable earnings has important reference or verification role for the authenticity of Book-earnings of listed companies.In fact,the market has also been aware of that.Therefore,this paper's most important implications in policy is that,if a listed company disclose the information of taxable earnings,it can reduce to some extent the misleading of the managed earnings for investors,and could even eliminate the excessive behavior of earnings management by using Book-tax differences.In one word, despite Book-tax differences has brong some troubles indeed,we should not be Discouraged.The reform direction of accounting standards toward the convergence of international and the reform of Book-tax toward divergence is irreversible in China.On the theme of this paper,we suggest that the Government to promulgated regulations as soon as possible.That is,enterprises must report taxable earnings in the published annual financial reports.The research in the field in China has just started. Limited to the restrictions of my academic level,cognitive ability and sources of information,the paper's study on Book-tax differences and related earnings management is only an attempt.Nevertheless,my efforts would help to sort out the sequence of researches and the development direction in this field,and could inspire future research.Finally,I put forward the following prospects:(1)The use of economic theory and empirical analysis to explain the system change; (2)Comprehensive weigh the economic consequences of earnings management;(3)Develop the assumption of income tax- earnings management;(4)The coincidence between tax planning and income tax-earnings management;(5)The intertwined relationgship between the application of the principle of caution and income tax-earnings management;(6) distinguished researches between listed companies and non-listed companies;(7)The related research with the implementation of the new tax system and the new accounting guidelines in China.