Management Earnings Forecasts and Book-Tax Differences

Abstract

This study is the first to investigate the incremental usefulness of book-tax differences (BTDs) to discretionary accruals in detecting earnings management to meet quarterly management earnings forecasts. Upward managed earnings that do not affect taxable income result in larger BTDs. This paper uses the ranked tax-to-book income ratio and decomposes BTDs in normal and discretionary BTDs, and tax avoidance activity. The findings show that higher discretionary accruals, larger BTDs, and more aggressive tax avoiding activity are associated with higher probability of meeting management earnings forecasts. The results imply that BTDs are incrementally useful to discretionary accruals in detecting earnings management. Moreover, the analysis shows that firms are more likely to meet management earnings forecast during the financial crisis of 2008.