Dennis Sundvik

Earnings Management Around Swedish Corporate Income Tax Reforms

Prior literature considers a change in the national corporate income tax (CIT) rate as a strong firm incentive to manage earnings. This article examines the link between two recent CIT reforms in Sweden and earnings management with a large dataset of private firms. The effects of tax rate cuts are estimated on aggregate measures as well as on decomposed measures of accrual-based earnings management. The results suggest that taxation clearly influences these firms in their high book-tax conformity setting. Downward earnings management is documented before the reduction in the CIT rate, consistent with research on public firms with lower book-tax conformity. Primarily accounts receivable is noted to drive these results. Weaker evidence is provided with the inventory and depreciation accrual vehicles. The tax effects are statistically and economically significant. Furthermore, the income-decreasing behaviour prior to the CIT reforms is observed to be persistent over time.

Outsourcing of Accounting Tasks and Tax Management: Evidence from a Corporate Tax Rate Change

ABSTRACT The aim of this article is to investigate if small firms react to a national corporate tax rate reduction by managing their taxable income. In contrast to previous studies, we also analyse whether outsourcing of accounting tasks affects the magnitude of the reaction. Based on a sample of Finnish firms and measures of earnings management, evidence is provided that firms with an internalized accounting function are more active tax planners in this context. This study suggests that outsourcing of accounting tasks increases the corporate tax reporting quality.

Initial stage clustering when estimating accounting quality measures with self-organizing maps

We use self-organizing maps as a clustering tool when estimating accounting quality.SOM local regression model outperforms commonly used industry models.Overall, commonly used industry models do not perform very well.SOM should be used on large and messy data. This study introduces self-organizing maps as a clustering approach for several measures in accounting that rely on local linear regression-based estimation models with an initial and essential clustering phase. Clustering by industry is the most frequently used approach in prior literature when estimating measures such as real activities manipulation or accruals quality. However, this approach has been subject to criticism due to its association with sample attrition and biased outcome measures. The purpose of our study is to develop and evaluate the performance of a self-organizing map (SOM) local regression-based estimation model for several measures of accounting quality. The SOM is built by utilizing general firm characteristics such as regular balance sheet items as cluster variables instead of model specific variables. According to the results, our SOM local regression models outperform previously suggested clustering methods. Simulation tests show that estimation models based on SOM clustering with general firm characteristics detect abnormality in the accounting quality measures much better than previously used clustering methods. By utilizing the SOM approach, the estimation process of the measures is significantly improved which results in more accurate outcome measures that can be used in various contexts including expert systems designed for auditors and investors.

A neural network approach to measure real activities manipulation

We use neural networks to measure three varieties of real activities manipulation.The multilayer perceptron approach outperforms traditional linear regressions.The multilayer perceptron approach performs better than self-organizing maps.Individual measures should be used instead of aggregated measures when applying linear regression. A growing body of literature is examining the concept of real activities manipulation in various contexts. In these studies, the researcher typically models abnormal real activities and draws inferences based on the output measures. Thus, the results of the studies hinge critically on the underlying models. We contribute by examining alternative approaches to measure three varieties of real activities manipulation. Neural network models based on a self-organizing map and a multilayer perceptron are used in variation to a frequently used linear approach. The purpose of the study is to examine whether the neural network models outperform linear-based models in the detection of real activities manipulation. According to the results, the multilayer perceptron models are remarkably strong while the traditional linear models are underachievers. These results are specifically evident when common comprehensive measures are used.

Tax-Induced Fiscal Year Extension and Earnings Management

Purpose - The purpose of this paper is to examine three different responses to the Finnish 2005 tax reform that, among other things, reduced the corporate tax rate and hiked dividend taxation. Focus lies on the factors influencing the decision to change the fiscal year-end and whether earnings management is more prevalent when the decision is not taken. Design/methodology/approach - This study uses the financial statement data of Finnish private firms and studies 350 fiscal year-end changing firms and 700 non-changing firms with logistic and linear regression analysis. Discretionary accruals are the proxy for earnings management. Findings - The results suggest that firms seize the window of opportunity and extend fiscal years depending on the magnitude of the expected tax savings. Firms that do not change their fiscal year-end engage in more tax-induced earnings management. In terms of economic consequences, the earnings management approach is less economically significant. Research limitations/implications - This study only examines a limited number of firms that change their fiscal year-end, hence, care has been exercised in generalising the findings. Practical implications - The findings may be considered when structuring future tax reforms, particularly when considering transition rules relating to changes in fiscal year-ends. The study may also have implications beyond tax reforms since the evidence of opportunistic changes in the fiscal year-end can be informative for tax authorities, independent auditors and creditors. Originality/value - This study contributes to the relatively scarce literature on private firm responses to tax policy changes by analysing both upward and downward earnings management, as well as changes in the fiscal year-end. This is in contrast to previous research that mainly focusses on listed firms and absolute earnings management or earnings management in one direction.

Do Auditors Constrain Intertemporal Income Shifting in Private Companies

This study investigates the association between private company auditing and intertemporal income shifting. Using a large reduction in the Finnish corporate tax rate as a strong incentive for income shifting and financial statement data coupled with proprietary information from the tax authorities, we analyse accruals and cost stickiness of small private companies. Our results reveal significant differences in accrual income shifting between audited and unaudited companies, but only among companies that on average could anticipate the tax reduction the most. Further, we find auditors to restrict sticky selling, general, and administrative cost behaviour that we hypothesise is associated with illegal actions. Additional tests expose a nontrivial number of incorrectly unaudited companies which are the ones mostly associated with income shifting. Taken together, our study highlights the effects of audit exemption and the importance of enforcement while also suggesting that the audit process is value adding for the tax authorities.

A review of earnings management in private firms in response to tax rate changes

Abstract In this paper, I present a review of tax accounting research with a specific focus on earnings management in response to changes in the corporate tax rate. While prior surveys of the tax accounting literature have a broad scope and focus primarily on publicly listed firms, I concentrate on studies examining private firms. These firms have stronger incentives to engage in tax-induced earnings management and recent evidence shows that firms in general defer earnings from high to low tax periods around tax reforms. I summarize contemporary studies, questions examined, and learnings. In addition, I discuss practical implications and outline future research possibilities.

Real Earnings Management in UK Private and Public Firms

This paper analyses real earnings management among private versus public firms. Using accounting data of British firms, we find that public firms overall engage in more earnings management through real operating activities. Furthermore, when clear incentives to manage earnings in a specific direction are present, such as to beat earnings targets, we also find that public firms manage their earnings in the expected direction more than private firms. Additional tests reveal that higher analyst coverage may mitigate the level of abnormal operating behaviour in certain settings while quality auditing is not a limiting factor. We also find that high managerial ownership among private firms is associated with less real earnings management. Our study contributes to the emerging literature on non-accrual earnings management and to the broader understanding about the private vis-a-vis public firm reporting and operating behaviour.