The effects of book-tax conformity and tax accounting incentives on financial accounting: evidence from public and private limited companies in Germany

Abstract

Using as a natural experiment, the German corporate tax rate decrease in 2001, this paper studies the effect of tax accounting incentives on financial statements in a setting where book-tax conformity is strong. We find that companies that generally balance their overall accounting strategy, i.e., they focus on tax accounting and financial accounting concurrently, are less willing to engage in tax-induced earnings management than are companies that do not focus on accounting strategy balancing. Moreover, we observe that tax accounting incentives in our natural experiment influence the earnings management behaviour of private companies but not of public companies. Our findings highlight the impact of tax accounting incentives on financial accounting when book-tax conformity is strong; therefore, these findings offer a new starting point for a sound discussion on the future of book-tax conformity.