How Much Will Firms Pay for Earnings That Do Not Exist? Evidence of Taxes Paid on Allegedly Fraudulent Earnings

Erickson, Merle; Hanlon, Michelle; Maydew, Edward L.

doi:10.2139/ssrn.347420

Cited by 73 publications

(73 citation statements)

References 35 publications

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“…As predicted by H1, when the firm has motivations to turn losses into gains, the firm prefers to employ more conforming earnings management strategies. As predicted by H2, when the firm has the motivation to avoid penalty cost associating with fraud being found, the firm prefers to employ more conforming earnings management strategies, which is consistent with the results in Erickson et al (2004), who document that their sample of firms with fraudulent financial reporting relied on significant amounts of conforming earnings management. In sum, these results show that when the firm has motivations to turn losses into gains, the firm prefers to employ more conforming earnings management strategies; when the firm engages in fraudulent activities, the firm prefers to employ less nonconforming earnings management strategies.…”

Section: Descriptive Statisticssupporting

confidence: 84%

“…Consistent with Erickson, Hanlon and Maydew (2004), income-increasing conforming earnings management results in a downward restatement of current tax expense as well as pretax income. Consistent with Phillips, Pincus and Rego (2003), income-increasing nonconforming earnings management results in a downward restatement of deferred tax expense and pretax income.…”

Section: Introductionmentioning

confidence: 65%

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Listed companies’ income tax planning and earnings management: Based on China’s capital market

Nan-wei

Cao

Lu-lu

2015

JIEM

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Abstract:Purpose: The Ministry of Finance issued the new China accounting standards on February 15, 2006, which requires the listed companies to use the balance sheet liability method for the income tax accounting. Thus, it gives us an opportunity to investigate the earnings management of listed companies from the perspective of income tax. Under the balance sheet liability method, our researches just try to investigate the relationship between the listed companies' income tax planning and earnings management.Design/methodology/approach: Our research approach combines theoretical analysis and empirical analysis. This paper first makes a deep theoretical analysis on the listed companies' choice between pretax earnings management activities and earnings management activities, and then we exemplify our theory. Next, we come up with two hypotheses based on the theoretical analysis, build up a restatement model and conduct the empirical examination. The empirical analysis employs the method of descriptive statistics and logistic regression.Findings: When engaging in earnings management, listed companies will trade off conforming and nonconforming earnings management from the perspective of income tax cost. We find that managers' motivations and purposes will influence the choice. When the company has motivations to turn losses into gains and has motivations to avoid penalty cost -417-Journal of Industrial Engineering and Management -http://dx.doi.org/10.3926/jiem.1310 associated with fraud being found, the company prefers to employ more conforming earnings management strategies. Research limitations/implications:The limitation in our research is as follows. First, we mainly focus on the conforming and nonconforming earnings management when the listed companies restate their financial statements. However after the issue of CAS2006, many listed companies still not disclose income tax account, which restrict our sample. Second, without the acquisition of private companies' data, our empirical results may have some errors. We will solve these problems in our future study.

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Section: Descriptive Statisticssupporting

confidence: 84%

Section: Introductionmentioning

confidence: 65%

Listed companies’ income tax planning and earnings management: Based on China’s capital market

Nan-wei

Cao

Lu-lu

2015

JIEM

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“…Rather, the unlocked potential for future research is likely in the context of real corporate decisions. The key point we 3 Erickson et al (2004) identify a setting and structure tests that avoid the need to compute "as if" tax and accounting numbers ("as if" the firm had made a different decision) which Shackelford and Shevlin argue biased results in prior research. See also Badertscher et al (2009) for an extension of Erickson et al to restatement firms.…”

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confidence: 99%

A review of tax research

Hanlon¹,

Heitzman²

2010

Journal of Accounting and Economics

Self Cite

2,052

646

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Abstract:In this paper, we present a review of tax research. We survey four main areas of the literature: 1) the informational role of income tax expense reported for financial accounting, 2) corporate tax avoidance, 3) corporate decision-making including investment, capital structure, and organizational form, and 4) taxes and asset pricing. We summarize the research areas and questions examined to date and what we have learned or not learned from the work completed thus far. In addition, we provide our opinion as to the interesting and important issues for future research. ______________________This paper was prepared for the 2009 Journal of Accounting and Economics Conference. We appreciate comments from Scott Dyreng, Mihir Desai (discussant), S.P. Kothari (editor), John Long, Ed Maydew, Lillian Mills, Tom Omer, Sonja Rego, Doug Shackelford, Terry Shevlin, Joel Slemrod, Cliff Smith, David Weber, Ryan Wilson, Jerry Zimmerman, George Zodrow, and conference participants at the JAE Conference as well as at the 2009 University of North Carolina Tax Symposium and the discussant there, Bill Gentry. All errors and omissions are our own. * Corresponding author: 100 Main Street, Cambridge, MA. email: mhanlon@mit.edu. 1 A Review of Tax Research IntroductionIn this paper, we review tax research in accounting as well as tax research in economics and finance to the extent that it is related to or is affected by research in accounting. Shackelford and Shevlin (2001) provide a careful and thorough review of empirical tax research in accounting in the prior Journal of Accounting and Economics review volume. Shackelford and Shevlin limit their review to research published in accounting outlets and describe the development of the relatively young archival, microeconomic-based income tax literature that arose from the Scholes andWolfson framework. In his discussion of the review, Maydew (2001) emphasizes the need for tax researchers in accounting to think more broadly and to incorporate more theory and evidence from economics and finance. We agree. Tax research has a long history in many disciplines; this fact cannot be ignored. Our goal in this paper is to integrate the theoretical and empirical tax research from accounting, economics, and finance, to summarize what is known and unknown, and to offer suggestions for future research.The multidisciplinary nature of tax research is what makes tax research exciting (yes, exciting), yet difficult. Tax research can be difficult not only because one has to follow tax studies in accounting, finance, economics, and law (through academic institutions, governmental agencies, and policy think tanks), but also because different disciplines often use different languages and have different perspectives. 1 For example, economists generally focus on tax compliance, tax incidence (such as who bears the corporate tax), investment and economic growth effects (such as how taxes 1 Slemrod (1992a) characterizes these differences as economists studying what corporations actually do and accountants stud...

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“…via higher tax payments) that likely exceeds the excess amount of value received by her. Based on a sample of 27 companies that have fraudulently inflated their earnings during the period 1996-2002, Erickson, Hanlon and Maydew (2004) find that the mean company paid an additional $11.84 million in taxes on the inflated earnings. This amount represents 1.3 percent of the market value of the mean company.…”

Section: Regulatory and Theoretical Backgroundmentioning

confidence: 99%

Firm-Level Heterogeneity of Clawback Provisions

Erkens

Gan

Yurtoğlu

2014

AMPROC

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We investigate the degree to which implementing a clawback policy, a special part of the executive's compensation contract, is an adequate governance mechanism to deter executives from misbehavior and to recover excess-pay. By focusing on the firm-level heterogeneity in the structure of clawbacks, we recognize that firms have considerable discretion in how they design their policies. We find that firms make heavily use of their discretion in adopting more or less deterrent policies and that most firms have weak clawback provisions. We analyze voluntary adopted clawbacks of all Russell 3,000 non-financial firms over 2007-2012. We conduct an extensive linguistic and a factor analysis to construct a deterrent index for 3,578 clawback observations. This index reflects the degree to which the contractual form of each clawback contains the core elements of a deterrent clawback policy. Our results, which also take into account the self-selection problem of voluntarily adopting a clawback, show that executive power, the executives' pay level, and weak corporate governance are associated with a low deterrent level. We also find that the deterrent level increases in directors' experience, corporate profitability and management ownership. Keywords: clawback provisions, excess pay, corporate governance, linguistic analysis JEL codes: G18, G30, G34, G39, K22, K29 Firm-Level Heterogeneity of Clawback Provisions AbstractWe investigate the degree to which implementing a clawback policy, a special part of the executive's compensation contract, is an adequate governance mechanism to deter executives from misbehavior and to recover excess-pay. By focusing on the firm-level heterogeneity in the structure of clawbacks, we recognize that firms have considerable discretion in how they design their policies. We find that firms make heavily use of their discretion in adopting more or less deterrent policies and that most firms have weak clawback provisions. We analyze voluntary adopted clawbacks of all Russell 3,000 non-financial firms over 2007-2012. We conduct an extensive linguistic and a factor analysis to construct a deterrent index for 3,578 clawback observations. This index reflects the degree to which the contractual form of each clawback contains the core elements of a deterrent clawback policy. Our results, which also take into account the self-selection problem of voluntarily adopting a clawback, show that executive power, the executives' pay level, and weak corporate governance are associated with a low deterrent level. We also find that the deterrent level increases in directors' experience, corporate profitability and management ownership.

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How Much Will Firms Pay for Earnings That Do Not Exist? Evidence of Taxes Paid on Allegedly Fraudulent Earnings

Cited by 73 publications

References 35 publications

Listed companies’ income tax planning and earnings management: Based on China’s capital market

Listed companies’ income tax planning and earnings management: Based on China’s capital market

A review of tax research

Firm-Level Heterogeneity of Clawback Provisions

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