Earnings Management in Response to Corporate Tax Rate Reduction Under an Imputation Tax System

Author:

Kuo Nan-Ting1,Lee Cheng-Few2

Affiliation:

1. Nankai Business School, Nankai University, 94 Weijin Road, Tianjin 300071, P. R. China

2. Rutgers Business School, Rutgers University, Piscataway, New Jersey 08854-8054, USA

Abstract

Our study explores how firms respond to a tax rate reduction under an imputation tax system. By exploring Taiwanese data, we find that firms engage in significant downward earnings management preceding a tax rate reduction, and this earnings management behavior reverses in the following year. We further explore what factors drive this finding, given that corporate tax avoidance reduces shareholder imputation credits and thus generates limited tax benefits to most shareholders. We argue and find evidence that three factors explain the tax-induced earnings management: (1) financing benefits from tax savings, (2) managerial rent extraction, and (3) the influence of foreign and domestic institutional shareholders. Our results suggest that factors other than shareholder tax benefits have significant effects on corporate tax avoidance, suggesting that firms still have strong incentives to avoid taxes under an imputation tax system.

Publisher

World Scientific Pub Co Pte Lt

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