Foreign earnings management of US multinational companies: The role of decision rights

The Effect of Changes in Income Shifting on Affiliate Managers' Internal Reporting Decisions*†

“…4 Second, we provide empirical evidence of the interplay between tax incentives and financial reporting practices inside MNCs. Since MNCs have many options for tax planning and earnings management practices both as a whole and as a collection of affiliates, our results contribute to the literature of the relation between tax and financial reporting incentives (Huang 2018;Frank et al 2009) by extending this relation to the European affiliates of MNCs. Because the affiliatelevel earnings management does not get eliminated upon consolidation, incentives to which affiliate managers respond will alter firm-level outcomes.…”

“…In contrast to the setting of Huang (2018), our hypothesized managerial behavior will be stronger when there are more limited information flows between headquarters and the affiliate, making it harder for headquarters to unwind the actions of the affiliate manager. 15 On the other 13.…”

“…Tax considerations also create additional goals that central management may impose on affiliate managers. For example, Huang (2018) shows that discretionary accruals within MNCs are tax efficient with centralized management control. The effect of centralized control is strongest when information asymmetry with the foreign operations is small or when the foreign legal enforcement environment is weak.…”

“…Stronger internal information flows may enhance tax planning, but our theory predicts that better information will reduce the ability of the affiliate manager to increase accruals strategically to offset this. Potentially offsetting the affiliate manager's incentives is Huang's (2018) argument about central management's goals for accruals. We acknowledge that all these forces may be at work.…”

“…Although earnings management has been extensively studied at the consolidated firm level, less is known about earnings management at the affiliate level, particularly in the presence of tax planning. Huang (2018) explores discretionary accruals of domestic operations versus foreign operations of US MNCs. She demonstrates that firms have more income-increasing accruals in foreign operations when the foreign tax rate is lower and when headquarters has greater centralized control, supporting the firm's tax strategy.…”