Do taxes encourage earnings management practice? New evidence for emerging economies

Purpose The reasons why a company may engage in earnings management (EM) practices are varied and do not necessarily respond to the fact of committing financial fraud, which may be either to smooth revenues, meet certain goals, avoid financial difficulties or have regulatory motivations. Our study will address the effect of income tax assessment on EM levels, measured according to each company’s discretionary accruals per year. Design/methodology/approach We use a sample of 125 companies from Argentina, Chile, Colombia, Peru and Mexico (Pacific Alliance) listed in the general index of each country. Using various controls widely recommended in the literature, we incorporate the effect of the 4 largest audit firms (BIG4) in a panel data format for more than 20 years. Findings Our results indicate that income tax has a positive and significant relationship with discretionary accruals, as well as being audited by one of the BIG4 negatively influencing a firm’s EM practice. With respect to controls, Return on Assets (ROA) and dividends paid have a positive and statistically significant effect on discretionary accruals. Originality/value Our study contributes to policy makers and regulators to make better decisions regarding the control of tax evasion or avoidance, given its incidence on the tax collection of each country, as well as the eventual public policies that can be adapted and created to reduce these effects. According to our understanding, there are no similar studies in emerging countries.