Tax system characteristics and country-level differences in earnings management

Kurzfassung/Abstract

We examine the extent to which European listed firms use deferred tax accounting to manage their GAAP earnings in order to meet financial analysts’ earnings forecasts. The cross-country nature of our data allows us to compare the use of this earnings management channel across countries and to relate these differences to certain country characteristics, in particular country-specific features of the tax system. Our results clearly document that European listed firms use deferred tax assets to inflate earnings when pre-manipulated earnings fall below the average analyst forecast. On average, they increase their return on assets by 0.2 percentage points (or 3 percent) through this channel. Our results also show a large variation in this effect across countries. Firms that face larger deviations between tax and financial accounting, higher tax rates, a stricter tax enforcement and a more lenient tax loss offset may, to some extent, make greater use of this earnings management channel.