The Usefulness Of The Tax Avoidance Proxy: Evidence From Korea

Abstract

This study aims to verify the usefulness of the tax avoidance proxy developed by Desai and Dharmapala (2006) in the setting where accounting-tax alignment is relatively high and aggressive tax planning is restricted. By using a large set of firms in Korea, I empirically test whether the tax avoidance proxy detects the management of book-tax and book-only accruals. My findings show that downward management of book-tax accruals for tax reporting purposes is not detected by the tax avoidance proxy. However, upward management of book-only accruals for financial reporting purposes is captured by the tax avoidance proxy. In addition, the tax avoidance proxy better detects simultaneous management of two accrual components than management of book-tax accruals alone. Lastly, the tax avoidance proxy is more powerful in detecting tax avoidance activities in a sample of firms with high tax and financial reporting costs than in firms that carry high tax costs but low financial reporting costs. The results of this study imply that the tax avoidance proxy can be a good indicator only when used for firms that are conscious of their financial reporting costs and have incentive to manage both taxable and book income at the same time under the setting where book-tax conformity is high and aggressive tax shelters are restricted. This study sheds light on the usefulness of the tax avoidance proxy which has been widely used in the accounting studies and provides a caveat to researchers that the proxy should be employed with caution and in appropriate setting.

The Accruals Quality and the Estimated Future Performance

“…The increase in discretionary accruals quality is a signaling pattern of management regarding the company's future prospects, so these empirical results strengthen (Riwayati, Markonah, & Siladjaja, 2016), regarding the communication process through the accruals for the prospects in future. Also, these empirical results reinforce research done by (Lee, 2016) by revealing an increase in the ability of investors to detect the accruals. By having a positive perception of increasing discretionary accruals quality, many investors were able to provide positive encouragement to management to improve the accounting information's quality, this result is to support it (Bassiouny & Ragab, Mohamed Moustafa, Soliman, 2016).…”

The Mapping Of Investor Perception On The High Financial Reporting Quality

“…The high earnings quality has covered up the high tax regulation compliances concerning agency costs in the subsequent period. This test is in line with (Lee 2016), in which the investor is concerned with the high probability of tax investigation, it has been related to a volatile fluctuation of agency cost in future periods.…”

“…Based on tax regulation compliance, (Hu, Cao, & Zheng, 2015) stated that the investor had not highlighted agency cost's volatile movement in the subsequent period. According to (Lee 2016), high tax conformity causes a positive perception of high compliance with tax regulation, this is related to agency cost and positive movement of the market price in the future because the investor has no tolerance for the infringement on the available tax rule. To test the impact of high earnings quality to predict the performance in the future, where indicated by future market value, so the first hypothesis can be arranged statistically, as follow : H1: Earnings Quality has a positive effect on Future Market Value.…”

“…When it is at a low level, the discretionary tax accruals quality is high, with a low probability of tax investigation. The tax management contains high compliances on tax regulation and conformity, suggesting that the management conducts tax regulation concisely (Lee, 2016). This can be seen as an administrative and legal process in tax reporting, such as penalty costs.…”

“…Practically, management has a different view of tax accruals, where tax saving is assumed to be an achievement by overlooking the high probability of tax investigation in subsequent periods (Ifada & Wulandari, 2015). This one leads to a negative investor's perception of tax accruals (Lee, 2016) since investors are aware of the high possibility of the tax investigation, related to future agency costs. The investor has zero-tolerance for violation of tax regulation, which indicates unprecedented agency costs in the following period.…”