Last‐Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts*

Abstract

We assert that the tax expense is a powerful context in which to study earnings management, because it is one of the last accounts closed prior to earnings announcements. Although many pre-tax accruals must be posted in the year-end general ledger, managers estimate and negotiate tax expense with their auditors immediately prior to earnings announcements. We hypothesize that changes from third-to fourth-quarter effective tax rates (ETRs) are negatively related to whether and how much a firm's earnings absent tax expense management miss analysts' consensus forecast, a proxy for target earnings. We measure earnings absent tax expense management as actual pre-tax earnings adjusted for the annual ETR reported at the third quarter.We provide robust evidence that firms lower their projected ETRs when they miss the consensus forecast, which is consistent with firms decreasing their tax expense if non-tax sources of earnings management are insufficient to achieve targets. We also find that firms that exceed earnings targets increase their ETR, but this effect is less significant. By studying the tax expense in total, rather than narrow components of deferred tax expense, our results provide general evidence that reported taxes are used to manage earnings. L'ultime instrument de gestion des résultats : l'utilisation de la charge d'impôts pour concrétiser les prévisions des analystes Keywords CondenséUtilise-t-on régulièrement la charge d'impôts de l'exercice pour parvenir aux résultats ciblés ? La chronologie de la préparation des états financiers et de la vérification indépendante porte à croire qu'il serait logique d'axer sur la charge d'impôts l'étude de la gestion des résultats dans le but d'atteindre des résultats ciblés. Compte tenu de la complexité de l'estimation de la charge d'impôts et du moment de la constatation des impôts préalablement à l'annonce des résultats, les auteurs croient que la charge d'impôts est riche et trop peu explorée dans l'étude de la gestion des résultats. Lorsque les gestionnaires sont encouragés à atteindre des résultats cibles déterminés, le compte de la charge d'impôts offre une possibilité ultime de gestion des résultats. La charge d'impôts est l'un des derniers comptes à être fermé avant l'annonce des résultats, étant donné que les autres changements liés aux bénéfices ont une incidence sur les comptes d'impôt.La charge d'impôts de l'exercice respecte également les conditions que Schipper (1989) juge nécessaires à la gestion des résultats. Selon elle, en effet, pour que les gestionnaires puissent « gérer les résultats », l'asymétrie de l'information entre gestionnaires et actionnaires doit persister. La charge d'impôts de l'exercice est difficile à estimer dans les grandes sociétés, en raison de la complexité de l'information que doivent recueillir les gestionnaires entre la fin de l'exercice et la date de l'annonce des résultats. Les éléments de la charge d'impôts totale qui présentent cette complexité et offrent la possibilité de planifier le taux d'imposition englobent la...

Earnings Management in South Korea: Using Tax Expenses

“…The complexity of computation for tax expenses and the discretion in estimating tax accruals result in information asymmetry persisting between managers and both auditors and shareholders. Dhaliwal et al (2004) provide evidence that firms lower their projected effective tax rates when they miss the analysts' forecast consensus, which is consistent with firms decreasing their tax expenses if non-tax sources of earnings management are insufficient to achieve the target. They also find that firms, which exceed earnings, target an increase of their ETR, but this effect is less significant.…”

Earnings Management through Tax Reserves and Auditor-Provided Tax Services

“…S&P 1500 index covers approximately 85% of the U.S. market capitalization and includes large, medium, and small cap firms. Consistent with Dhaliwal, Gleason, and Mills (2004) and Gleason, Pincus, and Rego (2017), this study investigates earnings management through tax reserves by examining the relationship between changes in tax reserves and pre-managed earnings (the earnings before the change of tax reserves), while controlling for other facts that might affect the changes in tax reserves. Findings are generally consistent with the expectations.…”

The Role of Additional Non-EPS Forecasts: Evidence Using Pre-Tax Forecasts

“…An example of this is the tax expense account. Dhaliwal et al (2004) and Cook et al (2008) provide evidence that managers use the tax account in a final effort to manage earnings.…”

“…Dhaliwal et al (2004) and Cook et al (2008) find that firms manage the tax expense account to meet analysts' after-tax earnings forecasts. Gleason and Mills (2008) examine the market reaction to this form of earnings management and find investors significantly discount the reward for beating analysts' forecasts through the manipulation of the tax expense account.…”