Financial Constraints And Income Tax Cost Of Earnings Management

Earnings management and tax management are two vital fields in capital market and tax.Based on cost-benefit principle,enterprises have to trade off the value of tax benefits against the detection costs associated with nonconforming earnings management,which impact firms' choice between earnings management strategies.On the one hand,firms have to bear income tax cost when doing conforming earnings management activities.On the other hand,nonconforming earnings management may lead to abnormal book-tax differences,triggering increased scrutiny by auditors,tax administration and CSRC.Hence,investigating how firms manipulate earnings management and what factors influence the choice between earnings management strategies is not only a major topic in academic research,but also concerned by stakeholders.Financing difficulty brought by economic downturn is a major issue most enterprises have to deal with.Current research shows enterprises with financial constraints have greater incentive to manage earnings.This paper examines he impacts of financial constraints on income tax cost of earnings management,which implies enterprises' choice between conforming and nonconforming earnings management strategies.This paper selects firms restated their earnings due to accounting irregularities in Shanghai and Shenzhen listed companies from 2008 to 2015 as the sample.We utilize the difference between originally reported and restated current tax expense to measure income tax cost of earnings management,and then investigate impacts of financial constraints on earnings management strategies.The results show that the more serious the financial constraints in enterprises,the higher the rate of nonconforming earnings management.Further research exhibits that tax enforcement is an effective external governance mechanism,which significantly decreases the positive relationship between financial constraints and nonconforming earnings management and aggregates income tax cost of earnings management.The possible contribution of this paper lies in two points.Firstly,current research investigates income tax cost of earnings management by testing the relationship between abnormal accruals and tax liability,which is difficult to distinguish abnormal tax liability from total tax liability.We hand-collect the change between originally reported and restated current tax expense to measure the amount of book-tax conforming earnings management,largely avoiding measurement error inherent in current research methods.Secondly,financial constraints is a general problem existing in most enterprises and has influence on corporate behavior in all directions.From the perspective of financial constraints,it not only provides a better understanding on what factors impact earnings management strategies,but also enriches the research on the consequence of financial constraints.The paper proceeds as follows.This study can be divided into six parts.Section one is a brief introduction,which describes the writing motivation,the contribution to current research and innovative points.Section two reviews related literatures,including earning management and income tax cost and financial constraints and tax avoidance.Section three clarifies important concepts and develops research hypothesis.We exhibit some examples to show the relationship between different earnings management strategies.and income tax cost.And we analyze hypothesis based on effective tax planning theory and information asymmetry theory.Section four is about empirical research design,including the models,how to select the sample through manual way,the data sources and the calculation process of nonconforming earnings management rate.Section five presents the empirical results and makes some corresponding analyses.Section six comes to relevant conclusions and gives practical policy recommendations from capital market,enterprise and tax bureau' point,and this part also acknowledges the defects existing in this paper and seeks the future research direction in this field.