An improved measure of conforming tax avoidance

Yang Lou, Yicheng Wang and Brian Wright

Journal of Financial Reporting and Accounting, 2023, vol. 23, issue 3, 1271-1301

Abstract: Purpose - This study aims to propose a new conforming tax measure based on the work of Badertscheret al.(2019). Design/methodology/approach - This study divides total tax avoidance/management (TM) into nonconforming and conforming portions through a regression. The residual of the regression is treated as the conforming tax measure. In addition, the new conforming tax measure is validated via three approaches. Then, this study examines the moderating effect of nonconforming earnings management (EM) on the relationship between conforming TM and firm performance. Findings - The empirical results show that the model has stronger explanatory power than the model proposed by Badertscheret al.(2019). Additionally, the validation results show that the mean value of the conforming tax measure is lower in quasi-private corporations (financially constrained companies) than in matched public corporations (nonfinancially constrained companies), and firms under high market capital pressure are less motivated to engage in conforming tax practices. Furthermore, nonconforming EM positively moderates the conforming tax–ROA association, implying that nonconforming EM can reduce financial reporting costs resulting from conforming tax practices. Originality/value - This study contributes to conforming tax research in the following ways. First, this study proposes a new conforming tax measure by substituting the cash book tax difference (BTD) for the BTD in the model of Badertscheret al.(2019) (“BKRW”). Second, this study demonstrates theoretically why the cash BTD should outperform the BTD in computing the BKRW conforming tax measure and confirm this empirically. Third, this study presents a three-way conceptual schema that divides corporations into two groups along each of three tax-relevant dimensions. The group of firms that use both conforming and nonconforming tax strategies have different characteristics compared to the other group. This study also validates the conforming tax measure across the two-group dichotomies.

Keywords: Conforming tax avoidance; Cash BTD; Nonconforming earnings management; Taxation; Financial accounting; Accounting; Financial reporting (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfrapp:jfra-07-2022-0259

DOI: 10.1108/JFRA-07-2022-0259

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