The Effect of Real Earnings Management on Tax Avoidance

Abstract

In line with the literature on several determinants of tax avoidance, this paper considers the impact of real earnings management on tax avoidance. Under the circumstances of divergent reporting incentives in tax and financial accounting purposes, firms may properly exploit discretionary accruals and tax subsidy for dual goals. On the other hand, firms that engage in real earnings management have relatively little chance to achieve it, and thus would have stronger motivation to seek for aggressive tax planning. In addition, firms that engage more in real earnings management are safer from regulator scrutiny relative to accrual management, which leads firm to be less sensitive to the risks of tax avoidance. Given greater motivation and favorable circumstances for tax avoidance, firms that engage more in real earnings management are expected to seek for more aggressive tax planning. Results from OLS regression support the prediction, and the impact of real earnings management on tax avoidance remains unchanged after controlling for the discretionary accruals.