세무상 이월결손금이 이익조정과 이익조정방법 선택에 미치는 영향 = The Effect of Net Operating Loss Carryforwards on Earnings Management and the Choice of Earnings Management Strategies

다국어 초록 (Multilingual Abstract)

Firms have incentive to adjust their reported incomes upward, but they have to consider increased tax costs associated with such an upward adjustment. However, firms with net operating loss carryforward (hereafter, NOLCF) will be more flexible in decisions to increase their reported income. It is because a firm`s tax costs may not increase proportionally to the upward income adjustment. We examine empirically the effect of NOLCF on a firm`s earnings management decisions as well as firms` income increasing strategies. We also investigate the tax consequences of earnings management and the effect of NOLCF on tax returns. We hypothesize that the more a firm has NOLCF available at the beginning of a year, the more will the firm manage their reported income upward. This relationship may be because that NOLCF would absorb the impact of upward earnings management on tax costs, and therefore a firm`s decisions for upward earnings management could be more flexible. Since NOLCF will be expired after a predetermined legal term(5 years in Korea), a firm which want to take advantage of the tax-saving benefits of NOLCF may have incentive to create sufficient taxable income before expiration of the legal term. That is, NOLCF would provide an incentive for upward earnings management within the allowed period. Therefore, we hypothesize additionally that the shorter the remaining expiration period of NOLCF, the greater is the firm`s incentive for upward reported income management in a specific year. A firm engaged in fraudulent earnings management have to worry about the possibility of being detected. Book-tax conforming earnings management to increase a firm`s reported income may have relatively low detection risk, but still has to bear higher tax costs. That is, book-tax confirming earning-increasing strategies have a positive side of low detection risk as well as a negative side of corresponding increase in tax costs. However, if a firm has NOLCF available at the beginning of the year, it could absorb the negative impact of upward earnings management on tax costs. Therefore, we hypothesize that a firm with NOLCF would choose booktax conforming earnings management strategies to avoid its risk of being detected. We have performed empirical tests using 352 firm-year sample firms with NOLCF from year 1999 to 2005. Our results show that firms with more NOLCF made more upward reported income managements and that firms with NOLCF expiring in a shorter period tend to increase their reported income intentionally. In summary, NOLCF can reduce firms` tax costs associated with upward income adjustment and therefore provide greater incentive to manage their reported income upward. This would not be desirable for a healthy financial reporting convention. We have also performed additional empirical tests using 135 sample firms that had been accused of overstating their reported earnings fraudulently. This is to investigate NOLCF`s effect on the choice of a firm`s earnings management strategies and tax returns. The empirical results show that firms with NOLCF choose booktax conforming earnings management strategies to avoid detection risk. Also, the results show that firms that do not have NOLCF but overstate its earnings through the book-tax conforming method tend to reduce its associated tax costs increase in a tax return through other available means such as aggressive loss inclusion. The results of our study imply that motivation to take advantage of the tax benefits of NOLCF before the NOLCF expiration date can impair the transparency and reliability of financial reporting. Therefore, policy makers should consider extending the NOLCF expiration period and/or widening a net operating loss carryback system. However, in the loss carryback system, a certain means is needed to prevent a firm`s big-bath practice to be exercised possibly for immediate tax benefits. Also, external auditors should perform their works more thoroughly for a firm with significant NOLCF and the firm with NOLCF expiring shortly. This study contributes to earnings management researches in that it provides empirical evidence that NOLCF can be direct incentive for upward reported earnings management. However, this study can not be generalized fully since it performs some of its tests using only those firms which are revealed to manipulate their reported earnings fraudulently. Further studies investigating the effect of NOLCF on a firm`s value will be interesting since NOLCF will provide tax benefits as well as opportunistic earnings management.

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