Political Cost (Dis)Incentives for Earnings Management in Private Firms

49 Pages Posted: 11 Mar 2007

See all articles by Neil Garrod

Neil Garrod

Thames Valley University - Professional Studies

Pirkovic Sonja Ratej

University of Ljubljana - Faculty of Economics

Aljosa Valentincic

University of Ljubljana - Faculty of Economics

Date Written: March 8, 2007

Abstract

We examine the extent to which economic incentives subject to political cost impact on accounting choice. We employ a setting with no agency factors to disguise economic incentives for earnings management. We find that profit firms manage earnings downward to reduce, but not entirely eliminate, current period corporate tax. Elimination of tax is constrained by political cost resulting from the increased possibility of a tax audit. That same political cost also provides an incentive to firms that are genuinely in a position where they would pay no tax in the current period to adopt earnings (and tax)-increasing accounting policies. Consistent with existing literature we find that some earnings management occurs at the operating profit level but, as expected, "real" economic transactions are not managed, as this would reduce the value of the firm and directly owner/manager wealth. Results are robust to variations in ownership structure, financial debt, collateral, varying deflators, etc.

Keywords: earnings management, private firms, agency relationships, political costs, tax management

JEL Classification: D82, G32, G38, H25, M41

Suggested Citation

Garrod, Neil W. and Ratej, Pirkovic Sonja and Valentincic, Aljosa, Political Cost (Dis)Incentives for Earnings Management in Private Firms (March 8, 2007). Available at SSRN: https://ssrn.com/abstract=969678 or http://dx.doi.org/10.2139/ssrn.969678

Neil W. Garrod

Thames Valley University - Professional Studies ( email )

Kings Road
Reading, Berkshire RG1 4HJ UK
United Kingdom

Pirkovic Sonja Ratej

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia

Aljosa Valentincic (Contact Author)

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia

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