Book-Tax Differences And Enterprise Financial Distress Prediction

Book-tax differences (BTDs) between a firm’s book income and tax income arises from appropriate separation mode of accounting standards and income tax law, which the book income should be adjusted in accordance with income tax law when calculating the tax income.Inconformity with income tax law,a firm has flexibilities in selecting accounting policies.That is different enterprises have different accounting treatment.However,tax law is mandatory and tax income is calculated according to hard-and-fast rules. Therefore, the reasons for the formation of BTDs are as follows:systematic differences and enterprise’s opportunism behavior.There exists information asymmetry between enterprises and investors in the not fully effective capital market, under which investors belong to information vulnerable position and they cannot gain efficiency information from the financial statements to make decisions.For external shareholders,especially small and medium-sized investors,an applicable financial distress early warning system needs to be set up that is suitable for them.The existing financial distress prediction models,focusing mostly on financial information and ignoring the importance of non-financial information,especially the tax income information,are static models based on the single phase of cross section data. This paper,adding BTDs to the basic financial distress prediction model and using a logistic discrete time hazard model in Shumway(2001),discusses whether BTDs can be a financial distress prediction indicator on one hand and compare the efficiency in predicting between financial distress prediction model based on the financial information and comprehensive financial distress prediction model based on the financial information and BTDs on the other hand.This paper first reviews relevant researches about BTDs and financial distress prediction and analyzes BTDs and financial distress prediction in theories,and then makes an analysis about the association between BTDs and financial distress. After the theoretical analysis,the paper proposes the hypothesis and does the empirical research using Chinese A-share listed companies data from2008to2013,which aimed at the effect of new income tax law. The results of descriptive statistics showed that book income of Chinese listed firms is generally smaller than the amount of taxable income, consistent with the fact that the income tax law is strict than accounting standards in terms of pre-tax deduction.The paper also carries on significance test between financial distress samples and normal enterprises,showing that BTDs,FINANCE and other variables have significant differences between two groups of samples.This paper constructs three types of financial distress prediction models by using discrete time hazard model and uses Logistic regression analysis to explore the ability of BTDs and financial information in predicting firm’s financial distress occurrence probability among above models.The results of regression analysis show that firms with larger positive BTDs and larger negative BTDs have bigger financial distress occurrence probability than those firms with small BTDs.Comparing with traditional financial distress prediction models,the models included BTDs, adding information to the traditional financial distress prediction models because the AUC squares and the classification accuracy of models have improved accordingly.Finally,this paper puts forward some proposals about capital market regulation,investors protection and financial distress prediction, hoping that laws,regulations and standards setters can consider multiple interests and enforce the regulation of information disclosure.As investors,not only should they improve professional abilities,but also considering other non-financial indicators, such as tax income and so on.