Work detail

Earnings Management under Financial Distress Conditions, the Effect of Tax Considerations

Author: Bc. Andrey Britskiy
Year: 2020 - summer
Leaders: Jiří Novák M.Sc., Ph.D., Deloitte Corporate Chair
Consultants:
Work type: Masters
MEF
Language: English
Pages: 84
Awards and prizes:
Link:
Abstract: This master thesis attempts to contribute to the existing earnings management literature
by examining whether tax avoidance incentives affect opportunistic accounting choices
in distress conditions. To address this issue, it investigates 2668 companies in the
quarters around breach of debt covenant spanning from 1996 to 2006. This allows to
analyze two distress scenarios: first, whether the companies having the opportunity to
minimize tax expenses and thus improve their financial stability, would deliberately
switch from engaging in aggressive upwards real earnings management to tax
considerations to mitigate the potential consequences of technical default; second,
whether the companies facing increased lender’s scrutiny after subsequent violation
are compelled to switch by the creditor. The results indicate that tax considerations do
not deter misreporting in the quarters around debt covenant violation. This thesis
further provides evidence against the debt covenant hypothesis: the companies in the
analyzed sample engaged in negative revenue manipulation in the quarters of new
breach of debt covenant and in the quarters in which the firms remained in violation.
In additional analysis, it was found that the above relationship is more prominent for
the companies exhibiting poor financial performance.

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