An Empirical Research Between Excessive Income-tax Differences And Earnings Quality

As a major component of accounting information, earnings quality has been usedas an important indicator of business performance assessment. Higher earnings qualityconveys an external signal of normal business operation. It helps to establish a goodcorporate image and enhance investor confidence. For listed companies, if earningsquality indicator is poor it will affect the economic behavior of the relevant sharesissued. Even more it will affect the company’s survival and development. Therefore, inorder to obtain and maintain good indicators of accounting earnings, companies oftenconsciously adopt earnings management tool.With many reforming of accounting standards and tax regulations, accountingincome disclosed in the financial reporting and taxable income disclosed in the taxreturns has a gradual separation. Since the beginning of the1990s, the Western financialcommunity has been working on the theory income-tax differences. In recent years,domestic empirical research about income-tax differences focus on the theoretical study.From the domestic and abroad published research, the appropriate separation ofaccounting standards and tax regulations will lead to a certain objectivity inevitability ofincome-tax differences. In addition to this inevitability and objectivity, the companydoes not rule out the artificial manipulation, and it is the artificial earnings manipulationthat constitutes existing subjective factors of income-tax differences. With theappropriate separation accounting standards and tax laws, it leads to further expand ofaccounting and tax differences, but also to provide an opportunity for businessmanagers to actively control the earnings. And to some extent it results in coexistencephenomena that many companies has a high profit and low income, such as Enron.It becomes one of the issues of concern of financial theory that how to correctlyunderstand and define objectivity and subjectivity of differences between accountingincome and taxable income. Domestic studies have found that the domestic income-taxdifferences containing accounting information can be used to predict the company’sfuture earnings capacity. But almost no existing researches separately define objectivelyincome-tax and income-tax differences manipulated and do relevant empirical analysis.Therefore, overview previous studies, which type of income-tax differences plays aleading role in the quality of accounting information? Total differences-includesobjective and manipulation factors, or just part of subjective manipulation? These issues are subject to further study and discussion of this article. Meanwhile, the existingliterature on earnings quality interpretation is only from the perspective of earningspersistence and rarely from studies involving tax differences. There are also rarelyin-depth and systematic studies about the relationship between income-tax differenceand earnings quality.Therefore, this paper takes it as topic and conducts the following studies. Firstly,by analysis of the factors affecting income-tax differences of China’s listed companies itidentifies the main affecting factors. Based on a certain objectivity and inevitability ofincome-tax differences it proposes the concepts of general and excessive income-taxdifferences, and excessive income-tax differences are just manipulation income-taxdifferences. Secondly, it builds the related models to define and measure excessiveincome-tax differences, and then study how excessive income-tax differences couldinfluence the quality of earnings. Underlying assumptions are proposed and testedthrough empirical study. It concludes that it is excessive income-tax differences thataffect earnings quality, not general differences. Finally, tax cost analysis about holdingexcessive differences are being done to test whether it is rational or not toincome-tax hold excessive differences. According to the main research content the paperis divided into the following sections:Systematical combing and overview are done about the theoretical income-taxdifferences at the beginning. And it respectively explains the causes of income-taxdifferences from three aspects: the institutional factors, earnings management and taxshelters. Combined with the existing literature, it summarizes the research results aboutearnings quality related in income-tax differences.Empirical research hypothesis directly affects the selected measurement modelthereby affecting the results of the study. Therefore, this paper in the third chaptermeasure of earnings quality from three angles: the growth, robustness and profitability.Then combining the institutional context and referencing to excessive investmentevaluation model, it model building econometric model to measure excessive taxdifferences. Based on a theory that subjective manipulation is just the main reason forthe excessive differences, the main hypothesis is put forward: it is excessive income-taxdifferences that affect earnings quality, not general differences.The fourth chapter based on the main assumptions proposes three differentassumptions, and uses multivariate regression measurement instruments to test theassumptions. The results show that excessive tax differences have a negative impact on three factors: earnings growth, earnings conservatism and long-term performance. Itcomplies with the main assumption in the paper. The conclusion has a theoreticalsignificance and practical value for improving the quality of the information of China’slisted companies.Holding excessive income-tax differences is proved to affect the company’searnings quality which are contrary to the original intention for high quality earningsexpectations. Then fifth chapter discusses the internal mechanism of holding excessiveincome-tax differences. Through the "income" and "cost" argument by analogy, cost ofrevenue model is built and multiple regressions are done. It concludes that holdingexcessive income-tax differences is owing to the reason of tax cost. Thus it proves thatholding excessive differences for listed companies is a rational behavior. The paperprovides empirical evidence for assisting the accounting standard setters and securitiesregulators to assess the impact of earnings management in general and authenticity offinancial reports.