Effects of corporate taxes on private firms’ earnings management: A regression discontinuity analysis

We examine the impact of tax incentives on private firms’ earnings management based on a tax reform in China. Firms established after January 2002 face significant tax reduction, thus creating a large and persistent discontinuity in tax rates by establishment date. Using the regression discontinuity design, we show that tax reduction substantially increases private firms’ incentives to manage earnings, and such effect is particularly pronounced when tax collection intensity and government interventions are low. A plausible mechanism is that private firms signal promising outlooks by managing earnings to attain greater financing and improve investment/operation levels when financial constraints are removed.