The Choice Among Accounting Alternatives and Management Compensation: Effects of Corporate Tax.

Abstract ABSTRACT: Does tax policy affect accounting choices? in this paper we examine how corporate tax affects management's accounting choices. Because (1) management compensation is typically linked to both accounting earnings and stock prices, (2) stock prices are related to cash flow distributions expected to be generated by the firm, (3) corporate-issued reports change cash flow assessments and, thus, affect compensation in a given period, and (4) changes in corporate tax rate changes the firm's cash flows, management will exploit its ability to "manage" reported accounting earnings in reaction to changes in tax rates, so as to maximize compensation. Assuming exogeneously determined generally accepted accounting principles, it is shown--using a stylized model--that increases in corporate tax rate induce choice of income-increasing accounting treatments. Empirical results applying logit analysis to a sample of compensation data are consistent with this implication of the model.