Political Cost (Dis)Incentives for Earnings Management in Private Firms
49 Pages Posted: 11 Mar 2007
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: Suggested Citation
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