WU International Taxation Research Paper Series

No. 2018 - 04

Tax Avoidance and Accounting Conservatism

Tobias Bornemann

Editors:

Eva Eberhartinger, Michael Lang, Rupert Sausgruber and Martin Zagler (Vienna University of
Economics and Business), and Erich Kirchler (University of Vienna)

Electronic copy available at: https://ssrn.com/abstract=3114054

 Tax Avoidance and Accounting Conservatism

Tobias Bornemann*
Vienna University of Economics and Business

February 2018

Abstract. This study analyzes the relation between accounting conservatism, future tax
rate cuts and countries’ level of book-tax conformity. Firms have an incentive to increase
conservatism in financial reporting when a tax rate cut is imminent to shift taxable income
into the lower taxed future. Using a panel of firms across 18 countries from 1995 to 2010 I
find that conditional conservatism is positively and significantly associated with future tax
rate cuts when book-tax conformity is high. This effect is particularly pronounced for firms
that concentrate the majority of their operations in the country in which the tax rate is cut.
In contrast, there is no significant relation between future tax rate cuts and unconditional
conservatism.

JEL Classification: H21, H25

Keywords: accounting conservatism, tax rate cuts, book-tax conformity

*
Vienna University of Economics and Business, Department of Finance, Accounting and Statistics,
Welthandelsplatz 1, 1020 Vienna, Austria.
The author can be contacted at tobias.bornemann@wu.ac.at.
This paper has benefited from helpful comments by Alissa Brühne (discussant), Michael Overesch
(discussant), Caren Sureth-Sloane, Eva Eberhartinger, and participants at the 3rd Vienna PhD Sem-
inar in International Business Taxation. Financial support by the Austrian Science Fund (FWF):
W1235-G16 is gratefully acknowledged.

Electronic copy available at: https://ssrn.com/abstract=3114054

Tax Avoidance and Accounting Conservatism

February 2018

Abstract. This study analyzes the relation between accounting conservatism, future tax
rate cuts and countries’ level of book-tax conformity. Firms have an incentive to increase
conservatism in financial reporting when a tax rate cut is imminent to shift taxable income
into the lower taxed future. Using a panel of firms across 18 countries from 1995 to 2010 I
find that conditional conservatism is positively and significantly associated with future tax
rate cuts when book-tax conformity is high. This effect is particularly pronounced for firms
that concentrate the majority of their operations in the country in which the tax rate is cut.
In contrast, there is no significant relation between future tax rate cuts and unconditional
conservatism.

JEL Classification: H21, H25

Keywords: accounting conservatism, tax rate cuts, book-tax conformity

Electronic copy available at: https://ssrn.com/abstract=3114054

1 Introduction

This study analyzes the relation between corporate taxation and accounting conservatism.

Accounting conservatism requires higher verification standards to be included in book in-

come for gains than for losses. Losses are therefore recognized timelier while gains are

deferred into the future (Basu, 1997; Watts, 2003a,b). A timelier loss recognition pro-

vides early information on value decreasing events and is associated with a broad array of

favorable implications for stakeholders. Accounting conservatism positively impacts the

value relevance of earnings (Brown, He, and Teitel, 2006), resolves information asymme-

tries (Lara, Osma, and Penalva, 2014), decreases adverse effects of CEO overconfidence

(Ahmed and Duellman, 2013) and managerial risk-taking (Kravet, 2014), decreases the

likelihood of future stock price crashes (Kim and Zhang, 2016), facilitates external borrow-

ing while fostering investment (Lara, Osma, and Penalva, 2016) and increases creditors’

recovery rate in case of default (Donovan, Frankel, and Martin, 2015).

While an asymmetric recognition of gains and losses in book income under conservative

accounting provides stakeholders with early and relevant information, it simultaneously

shifts taxable income into the future and defers tax payments. In periods of steady cor-

porate tax rates a deferral of tax payments decreases their present value (Watts, 2003a).

Additionally, an increase in accounting conservatism can materialize in a significant tax

benefit if a tax rate cut is imminent. Then losses are recognized during the higher taxed

earlier period while taxable income is shifted into the lower taxed later period. A tax

rate differential between periods therefore provides an incentive to increase conservatism

shortly before the tax rate is cut. Recent research showed that firms respond to tax rate

differentials across borders (Collins, Kemsley, and Lang, 1998; Bartelsman and Beetsma,

2003; Huizinga and Laeven, 2008; Klassen and Laplante, 2012) and time (Guenther, 1994;

1
Maydew, 1997; Lin, Mills, and Zhang, 2013; Andries, Cools, and van Uytbergen, 2016) to

decrease their accounting effective tax rate (ETR) (Dyreng, Hanlon, and Maydew, 2008).

The incentive to increase accounting conservatism prior to a tax rate cut, however, may

be mitigated by a lower degree of book-tax conformity. Thus, an increase in accounting

conservatism that affects book income is not necessarily reflected in taxable income on a

one-to-one basis. Whereas financial accounting standards try to provide early and useful

information to stakeholders, tax accounting often follows a revenue-raising function and is

subject to political processes (Hanlon, 2005; Hanlon and Heitzman, 2010). Tax accounting

therefore often requires less conservative accounting, as reflected, for example, in longer

depreciation periods. Hence, a low degree of book-tax conformity potentially undermines

the tax benefit associated with an increase of accounting conservatism shortly before a tax

rate cut. Against this backdrop, this study analyzes the association between future tax

rate cuts on the firms’ level of accounting conservatism and countries’ degree of book-tax

conformity as a potential mediator.

Recent research on the determinants of accounting conservatism strongly supports a

theory of accounting conservatism serving as a contracting device that helps to overcome

information asymmetries and agency conflicts. For example, firms with higher informa-

tion asymmetries between managers and investors experience higher levels of conservatism

(LaFond and Watts, 2008). Furthermore, accounting conservatism increases in the share

of outside directors with stronger monitoring incentives (Ahmed and Duellman, 2007) and

decreases in the controlling owner’s ownership share (Bona-Sanchez, Perez-Aleman, and

Santana-Martin, 2011). Thus, accounting conservatism primarily varies with firms’ infor-

mation environment. Firms that face larger information asymmetries between managers

and stakeholders as well as firms with stronger corporate governance enforce higher levels

of conservatism (Lara, Osma, and Penalva, 2009) to provide better and timelier informa-

2
tion to stakeholders. Further work in this area focuses on the interaction and determinants

of conditional and unconditional conservatism. Unconditional conservatism is triggered

with the inception of the asset and independent from bad news or triggering events (Basu,

1997). In contrast, conditional conservatism depends on news or triggering events such as

necessary impairments to an asset (Beaver and Ryan, 2005). For example, Qiang (2007)

shows that taxation induces unconditional conservatism only. This study, however, does

not explicitly account for changes in the tax rate and the incentives that go along with

tax rate cuts. I try to shed more light on the question if taxation induces conditional

conservatism. In contrast to prior research, I show that there is a strong positive associ-

ation between conditional conservatism and taxation, but only when there are imminent

changes in the tax rate.

Using three different proxies for accounting conservatism including the firm-level timeli-

ness of earnings (C-Score) (Khan and Watts, 2009) based on the Basu timeliness coefficient

(Basu, 1997), cash flow and earnings skewness (Givoly and Hayn, 2000) and the persis-

tence of negative accruals (Givoly and Hayn, 2000), I find that decreases in the corporate

tax rate are significantly and positively associated with increases in firms’ conditional

conservatism in the year prior to the tax rate cut. This effect is particularly pronounced

in a sub-sample of firms located in countries with a high degree of book-tax conformity.

Furthermore, the findings are robust when limiting the analysis to firms that concentrate

the majority of their operations in the country in which the tax rate is cut. In contrast,

my tests do not provide any support for the prediction that decreases in the corporate tax

go along with increases in unconditional conservatism.

There are several challenges in testing the relation between future tax rate cuts and

accounting conservatism. Firstly, corporate tax rates remain fairly stable over longer pe-

riods of time and affect a broad number of firms making it difficult to infer causal effects.

3
I control for these potential concerns by drawing on a large sample of firms across 18

different countries and a 15 year sample period (1995-2010) that covers a battery of tax

rate changes. Secondly, book income does not necessarily equal taxable income. Thus, tax

accounting rules may partly reverse conservative accounting in financial reports. There-

fore, a deferred dollar of accounting income may not fully map into a deferred dollar of

taxable income depending on the degree of book-tax conformity the firm faces. I address

this challenge and approximate each country’s degree of book-tax conformity using an em-

pirical book-tax conformity measure developed by Atwood, Drake, and Myers (2010). An

empirical measure of book-tax conformity overcomes concerns with other measures based

on subjective assessments. Third, it is empirically challenging to distinguish discretionary

and mechanically driven accounting conservatism. Although managers face discretion in

accounting choice to steer the level of conservatism, recent literature shows that proxies

used to capture conservatism also might as well capture the non-discretionary part of

accounting conservatism (Roychowdhury and Martin, 2013; Lawrence, Sloan, and Sun,

2013). I try to address this concern and proxy accounting conservatism using three dif-

ferent measures including the firm-specific proxy C-Score developed by Khan and Watts

(2009). Khan and Watts (2009) show that C-Score is varying at the firm-level with spe-

cific events such as a significant increase in litigation risk. Lastly, multinational enterprises

commonly pay taxes in various countries. Tax payments are usually based on local un-

consolidated financial statements while empirical conservatism proxies mostly depend on

consolidated financial data. In a robustness test I limit my analysis to firms that hold at

least 90% of their assets, generate at least 90% of their sales and earn at least 90% of their

income in the country in which the tax rate is cut. The results hold and are even stronger

in this sub-sample of firms concentrating their activities to the country in which the tax

rate is cut.

4
 This paper aims to contribute to several streams of literature. Firstly, this paper

adds to the stream of literature assessing the determinants of accounting conservatism

(Ahmed and Duellman, 2007; LaFond and Watts, 2008; Lara, Osma, and Penalva, 2009;

Bona-Sanchez, Perez-Aleman, and Santana-Martin, 2011). Secondly, I shed additional

light on the consequences of corporate tax avoidance especially tax avoidance via inter-

temporal profit shifting (Guenther, 1994; Maydew, 1997; Lin, Mills, and Zhang, 2013;

Andries, Cools, and van Uytbergen, 2016). Thirdly, this paper contributes to the ongoing

and topical debate on the benefits and/or drawbacks of book-tax conformity in financial

accounting (Desai, 2005; Hanlon and Shevlin, 2005; Atwood, Drake, and Myers, 2010).

The paper proceeds as follows. After formulating my hypotheses using a model that

explains the relation between anticipated tax rate cuts on firms’ level of accounting con-

servatism and moderating effects of book-tax conformity in section 2, I present variations

in corporate tax rates across 18 different countries from 1995 to 2010 in section 3. Section

3 also provides more details on the conservatism and book-tax conformity measures used

in the study as well as details on the sample used. In section 4 I present the empirical

tests and results and section 5 concludes.

2 Model and hypotheses

In the following I construct a model to predict the effect of corporate tax rate changes

on firms’ level of accounting conservatism. I assume a firm that acquires a capital stock

K in t = 0 that decays over two periods to keep the model as simple as possible. The

capital stock economically decays at a rate δ over time. The accounting system in place

depreciates K at a rate γ with γ ≥ δ. The firms’ accounting system is unconditionally

conservative if it depreciates assets faster than their actual economic lifetime (γ > δ) or

unbiased if accounting depreciation equals economic decay (γ = δ). In the first period the

5
capital stock experiences an unexpected downward shock to its market value . Hence,

the capital stock’s total loss in economic value amounts to (δ + )K in the first period

whereas accounting depreciation is γK in the first period. The accounting system requires

an impairment of the asset to its market value (1 − δ − )K whenever (δ + )K > γK

(news dependent or conditional conservatism). As a result, unconditional conservatism

is independent from any triggering events such as economic shocks to the value of the

asset and pre-empts conditional conservatism (Beaver and Ryan, 2005). The required

impairment of the asset in the first period therefore is given by

λ̄ = δ +  − γ. (1)

Subsequently, the required impairment λ̄ is decreasing in the level of the accounting sys-

tem’s unconditional conservatism γ. I further assume that the capital stock is fully decayed

after two periods without any salvage value (K = 0 in t = 2).

I assume the firm earns cash flows x in each period t resulting in pre-tax accounting

income of x − (γ + λ)K + x − (1 − (γ + λ))K = 2x − K. The firm has to pay taxes

at tax rates τt (t ∈ (0, 1)) based on taxable income. The tax rate drops at the end of

the first period with probability 0 ≤ p ≤ 1 so τ1 ≥ τ2 has to hold. Taxable income may

diverge from pre-tax accounting income, because tax accounting provides for different

accounting rules than financial accounting. Taxable income in both periods is given by

x − α(γ + λ)K + x − (1 − α(γ + λ))K where α denotes the degree of the country’s book-tax

conformity. I assume that the tax system has a strict revenue raising function (Hanlon,

2005) for the welfare state and does not provide any tax incentives (e.g., faster depreciation

schemes), thus 0 < α < 1 has to hold.

The manager privately observes the shock to the market value of the asset  in period

6
1 and chooses the impairment level λ for financial accounting purposes. The manager can

truthfully communicate the economic downward shock to the capital stock’s market value

via the accounting system so λ = λ̄ has to hold. Alternatively, the manager can exploit

the information asymmetry to impair the asset to a privately optimal degree so λ 6= λ̄.
c(λ−λ̄)2
Deviating from λ̄ triggers additional convex costs to the firm and/or manager 2

where c denotes a fixed cost factor. Costs can be thought of as personal costs of effort

to the manager to implement a privately optimal impairment level, additional expected

concealment costs or penalties triggered by audits or negative capital market reactions to

decreasing profits. Figure 1 illustrates the timing of the model.

Figure 1: Sequence of events

t=0 τ1 t=1 τ2 t=2

Firm acquires Tax rate τ drops End of firm

capital stock K with probability p
Manager observes λ̄
Manager chooses λ∗

The manager chooses the optimal impairment λ∗ at the end of the first period to

maximize the firm’s after-tax profits given by

c(λ − λ̄)2
π = 2x − K − τ1 (x − α(γ + λ)K) − (p τ2 + (1 − p)τ1 )(x − α(1 − (γ + λ))K) − (2)
2

with the first order condition

∂π
= 0. (3)
∂λ

The maximization problem solves for the optimal impairment rate λ∗ in t = 1 given by

p α K (τ1 − τ2 )
λ∗ = λ̄ + . (4)
c

7
 The model predicts several effects that are discussed in the following. Optimal im-

pairment λ∗ in period 1 should be interpreted as follows. Conditional conservatism is

increasing in λ∗ . The capital stock K is increasingly written down in the first period

shifting taxable income to the lower taxed period 2. To assess the effect of a tax rate cut

(τ2 < τ1 ) on the optimal impairment I use the following comparative static

∂λ∗ pαK
=− < 0. (5)
∂τ2 c

I require strictly positive values for p, α and K. Thus, the optimal impairment rate and

conditional conservatism is decreasing in τ2 . Put differently, the higher the expected tax

rate reduction in period 2, the higher the level of conditional conservatism in period 1. I

therefore predict the following

H1: Conditional conservatism is positively associated with the tax rate differential

between two periods (τ2 − τ1 ).

The model also predicts the effect of the country’s degree of book-tax conformity on the

optimal impairment rate in the first period indicated by the following comparative static

∂λ∗ p (τ1 − τ2 ) K
= > 0. (6)
∂α c

Thus the optimal impairment rate λ∗ is strictly increasing in the country’s book-tax confor-

mity. The intuition is that if book-tax conformity is high, conservative accounting choices

in financial accounting map into taxable income to a larger extent relative to countries in

which book-tax conformity is low.

H2: A positive association between firms’ conditional conservatism and a future tax

rate cut is especially pronounced if book and taxable income is strongly conformed (high

book-tax conformity).

8
3 Data and sample

3.1 Corporate tax rate variation across countries

To answer whether firms increase conservatism in financial reporting shortly before a tax

rate cut requires sufficient variation of corporate tax rates within countries and over time.

However, countries do not frequently adjust their corporate tax rates making it necessary

to look at larger time spans. Over the last three decades there has been a significant down-

ward trend in corporate tax rates across countries while tax bases were usually broadened

(also known as tax rate cuts cum base broadening). This downward trend is evident from

Figures 2, 3 and 4 that show the trend of various countries’ corporate tax rates from 1990

to 2015. Figure 2 presents corporate tax rates for Austria, Belgium, Denmark, Finland,

France and Germany. Figure 3 shows corporate tax rates for Greece, Italy, Japan, Nether-

lands, Norway and New Zealand. Figure 4 represents Poland, Portugal, South Korea,

Spain, Sweden and the UK.

< Insert figure 2, 3, 4 here >

On average the 18 countries outlined decreased their corporate income tax rate from

41.26% in 1990 to 26.70% in 2015. However, countries adjusted their corporate tax rates

differently over time. Whereas some countries significantly decrease their corporate tax

rates within one year (e.g., Austria in 2004 by 9% or Germany in 2008 by 10%), other

countries have staggered corporate tax rate changes over longer periods of time. The

United Kingdom, for example, decreased their corporate tax rate from 30% in 2008 to

20% in 2015 in annual steps ranging from 1% to 2%. In the used sample, I count in total

105 decreases in the corporate tax rate across 18 countries from 1995 to 2010. The average

tax rate differential from one year to another year is 3.4%. I count eight major corporate

tax rate cuts (≥ 5 percentage points) across six countries (Austria, Belgium, Germany,

9
France, Italy and Norway) without any changes in the tax rate two years prior or after the

drop in the tax rate. I use this variation in corporate tax rates across countries and time

to analyze the question if firms’ level of conservatism is positively associated with future

tax rate cuts.

3.2 Measuring accounting conservatism

To assess the effect of corporate tax rate changes on firms’ level of conservatism in financial

reporting, I use three measures of accounting conservatism to proxy for conditional and

unconditional conservatism. All variables are defined in detail in Table 1 in the appendix.

The first proxy to measure conditional conservatism is C-Score (Khan and Watts, 2009)

based on the Basu (1997) asymmetric timeliness measure. The Basu (1997) asymmetric

timeliness measure captures the responsiveness of earnings to good and bad news proxied

by stock market Returns. Specifically, earnings are regressed on stock market Returns,

an indicator variable for negative Returns and the interaction between Returns and the

indicator for negative Returns. If the accounting system is conservative then earnings pick

up bad news (negative stock Returns) relatively quicker than good news (positive stock

Returns) as indicated by a positive coefficient on the interaction term. The Basu (1997)

asymmetric timeliness measure is based on annual cross-sectional regressions providing

variation in conservatism only over time and not firms. In contrast, C-Score provides both

time and cross-sectional variation as a proxy for conditional conservatism. Khan and Watts

(2009) argue that a firm’s level of conditional conservatism depends on its market-to-book

ratio, its Size and Leverage providing cross-sectional variation across firms. C-Score is

frequently used in recent studies that assess determinants and implications of conditional

conservatism (e.g. Ahmed and Duellman (2013) or Lara, Osma, and Penalva (2014)).

C-Score measures the relative timeliness of earnings to bad news over good news at

10
the firm level and is estimated as follows. The Basu (1997) asymmetric timeliness measure

serves as a start and is given by the following regression model

Xi = β0 + β1 Di + β2 Ri + β3 Di × Ri + i , (7)

where i is the firm index, X is net income before extraordinary items scaled by lagged

market value of equity, R denotes annual Returns to proxy for news obtained by accu-

mulating monthly Returns starting from the fourth month after the firm’s fiscal year end,

D is a dummy variable set equal to 1 if Returns (news) are negative (R < 0) and set

to 0 otherwise. The coefficient β2 picks up the responsiveness of earnings to good news

(positive stock Returns). β2 + β3 captures the responsiveness to bad news (negative stock

Returns) and β3 captures the incremental timeliness of earnings to bad news relative to

good news. Khan and Watts (2009) argue that coefficients β2 and β3 are linear functions

of the firm’s firm-year characteristics firm size (Size), market-to-book ratio (MTB) and

Leverage ( Leverage) and are defined as follows

G-Score = β2 = µ1 + µ2 Sizei + µ3 M T Bi + µ4 Leveragei , (8a)

C-Score = β3 = λ1 + λ2 Sizei + λ3 M T Bi + λ4 Leveragei , (8b)

where Size is the natural log of market value of equity, MTB is the firm’s market-to-book

ratio and Leverage is total debt scaled by market value of equity. Substituting equation

(8a) and (8b) into regression model 7 yields the annual cross-sectional regression model

to estimate the responsiveness of earnings to good news (G-Score) and the incremental

11
responsiveness of earnings to bad news over good news (C-Score) at the firm level

Xi = β1 + β2 Di + Ri (µ1 + µ2 Sizei + µ3 M T B + µ4 Leveragei )

+ Di Ri (λ1 + λ2 Sizei + λ3 M T Bi + λ4 Leveragei )

(9)
+ (σ1 Sizei + σ2 M T Bi + σ3 Leveragei + σ4 Di Sizei

+ σ5 Di M T Bi + σ6 Di Leveragei ) + i .

The coefficients µi and λi are estimated using annual cross-sectional regressions and there-

fore vary over time, but not in the cross-section. The annual coefficients µi and λi are

then used to estimate G-Score (8a) and C-Score (8b). Cross-sectional variation in C-

Score is added through cross-sectional variation in firm-level characteristics (Size, MTB

and Leverage). Thus, C-Score measures firm-level conservatism across years. Conditional

conservatism is increasing in C-Score.

The second measure for conservatism, Con-Acc, measures unconditional conservatism

and captures the persistent use of negative accruals (Givoly and Hayn, 2000; Ahmed,

Billings, Morton, and Stanford-Harris, 2002). I define Con-Acc in line with prior research

as net income before extraordinary items less cash flow from operations plus deprecia-

tion expense deflated by average total assets and averaged over the previous three years,

multiplied by negative one (Ahmed and Duellman, 2013). Unconditional conservatism is

increasing in Con-Acc.

The last measure to proxy for unconditional conservatism is Skewness and is defined

as the difference between cash flow skewness and earnings skewness (Givoly and Hayn,

2000; Ahmed and Duellman, 2013). Put formally, earnings and cash flows skewness are

defined as (x − µ)3 /σ 3 where µ and σ are the mean and standard deviation of earnings and

cash flows over the last five years. Unconditional conservatism is increasing in Skewness.

12
3.3 Measuring book-tax conformity

To assess the effects of book-tax conformity on the association between future tax rate

cuts and accounting conservatism, I draw on the book-tax conformity measure developed

by Atwood, Drake, and Myers (2010). Atwood, Drake, and Myers (2010) define book-

tax conformity as “the flexibility that a firm has to report taxable income that is different

from pre-tax book income”. They base their measure of book-tax conformity on the con-

ditional variance of yearly tax expense in a country for a given level of pre-tax income.

To construct the measure Atwood, Drake, and Myers (2010) use annual cross-sectional

regressions of current tax expense on pre-tax book income, estimated foreign pre-tax

book-income and total dividends all scaled by total assets. Accordingly, the root mean-

squared error (RMSE) from the regression provides an unbiased estimate of the standard

error indicating the range of tax expense the firm can report for a given level of pre-tax

income. Higher (lower) values of RMSE indicate a broader range of reported tax expense

per unit of pre-tax income suggesting a lower (higher) degree of book-tax conformity for

the country-year.

< Insert Table 2 here >

I construct the Atwood, Drake, and Myers (2010) yearly book-tax conformity measure

for each of the 18 countries in the sample. Table 2 reports the average value of RMSE

over the whole sample period for each country and provides values of RMSE provided in

Atwood, Drake, and Myers (2010) for comparison. I construct a rank for each country

in each year BT CRank that indicates the country’s degree of book-tax conformity in

the respective year according to RMSE. A higher (lower) rank indicates a higher (lower)

degree of book-tax conformity. The results are comparable to reported values of RMSE

by Atwood, Drake, and Myers (2010). Differences in values are potentially attributable to

13
differences in sample years. The sample years used in Atwood, Drake, and Myers (2010)

range from 1992 to 2005. My measure is constructed for sample years from 1995 to 2010.

I acknowledge that there are additional measures to proxy for a country’s degree of re-

quired book-tax conformity. For example, Watrin, Ebert, and Thomsen (2014) construct a

measure of a country’s degree of book-tax conformity using firms’ unconsolidated financial

accounts. This approach potentially provides a more accurate measure as tax payments

of European firms are based on unconsolidated financial statements. In contrast, consoli-

dated financial accounts comprise tax payments in various countries and are subject to a

consolidation process. However, the measure is limited to European countries. Although

my sample mainly comprises European countries, data limitation on firms’ unconsolidated

accounts prior to the year 2007 restrict my analysis on the Atwood, Drake, and Myers

(2010) book-tax conformity measure. Using an empirical measure overcomes challenges

with other existing measures on book-tax conformity that rank countries based on sub-

jective assessments of a country’s degree of book-tax conformity such as Alford, Jones,

Leftwich, and Zmijewski (1993) or Hung (2000).

3.4 Sample and descriptive statistics

To test my hypotheses I draw on firm-level and stock return data retrieved from the

Datastream and Worldscope database provided by Thomson Reuters to construct a panel

of 37,880 firm-year observations ranging from 1995 to 2010. A 15-year time span from 1995

to 2010 covers a broad range of tax rate changes in various countries. The final sample

comprises firms located in 18 different countries. As conditional conservatism proxies

require stock return data to measure the timeliness of bad news recognition (proxied by

Returns) in firms’ earnings, my sample is restricted to publicly listed firms. Table 3

provides an overview of the number of firms and firm-year observations per country in the

14
sample.

< Insert Table 3 here >

To build the sample, I start with all listed firms in the Thomson Reuters’ Worldscope

database from 1995-2010 (168,227 observations) and drop observations with missing ob-

servations required for (in)dependent variables (less 115,025). Further I drop observations

with stock prices less than USD 1 in line with Khan and Watts (2009) to construct C-

Score. Next, I eliminate firm-year observations with market values less than USD 10,000

and observations in the 1st and 99th percentile of observations (less 14,017) to prevent

outliers from distorting the results (Becker, Jacob, and Jacob, 2013). The final sample

comprises 37,880 firm-year observations and 4,835 unique firms across 18 countries. I

acknowledge that eliminating observations in the 1st and 99th percentile of observations

significantly reduces the sample size. However, the sample’s final size is comparable to

other studies using Worldscope data (e.g. (Becker, Jacob, and Jacob, 2013)). Table 4

presents the sample selection in detail.

< Insert Table 4 here >

Table 5 summarizes all descriptive statistics of the sample. Although my sample differs

from other studies in that I also include non-U.S. firms, my results for C-Score, Skewness

and Con-Acc are comparable. The mean (median) of C-Score is 0.062 (0.023) for my

sample which is comparable to other studies. For example, Ahmed and Duellman (2013)

report a mean C-Score of 0.060 while Lara, Osma, and Penalva (2014) report a mean C-

Score of 0.098. Also the mean of Con-Acc is comparable to Ahmed and Duellman (2013).

The mean of Skewness is less compared to other studies. Note that Con-Acc and Skewness

have fewer observations (26,844 and 9,543) since both measures require consecutive data

points over time. However, the comparable results of C-Score, Skewness and Con-Acc

15
provide some comfort that the proxies are correctly estimated. The average firm in the

sample is relatively large (mean for Size is 15.415) compared to studies that sample U.S.

firms. I attribute this to the fact that capital markets outside the U.S. are usually limited

to larger firms. The mean (median) of Leverage is 0.835 (0.342), of Sales growth 0.086

(0.047) and of Op. cashflow 0.146 (0.108). The mean (median) of MTB is 1.896 (1.357)

and of CEO shares 0.004 (0.001). In line with prior research I set missing values for R&D

expense equal to zero resulting in a left skewed distribution of R&D expense with mean

(median) of 0.019 (0.000). The descriptive statistics are comparable to conventional levels.

< Insert Table 5 here >

4 Empirical tests and results

First, I test if firms’ level of accounting conservatism is positively associated with an

imminent tax rate cut. I define a large tax rate cut as a reduction in the corporate

tax rate of 5 percentage points or more without any changes in the corporate tax rate

two years before or after the tax rate is cut. However, I cannot control for additional

changes affecting the tax base. While there potentially has not been a significant change

in the effective tax rate, earlier research on the salience of statutory tax rates provide

some comfort that firms respond to changes in the statutory tax rate and not so much to

changes in the effective tax rate (Buettner and Ruf, 2007; Blaufus, Bob, Hundsdoerfer,

Kiesewetter, and Weimann, 2013; Amberger, Eberhartinger, and Kasper, 2016).

In total, the sample comprises five large tax rate cuts across four countries: Austria,

Belgium, Germany and Italy (twice). Figure 5 and 6 provide a first indication of firms’

level of conditional conservatism around a large tax rate cut. Figure 5 pools all firm-year

observations of the four countries and plots the average value of C-Score over time. The

year in which the tax rate is cut is indicated by t = 0. Hypothesis 1 indicates that firms

16
increase conditional conservatism when a tax rate cut is imminent. Three years before the

tax rate cut the mean of C-Score across the four countries is about 0.02 and increases to

0.25 on year before the tax rate is cut. In the following three years the mean of C-Score

decreases again to approximately 0.08. Accordingly, C-Score increases and peaks in the

year before the tax rate cut just to flatten again after the tax rate cut providing some

first evidence in support of hypothesis 1. The response in C-Score is comparable to event

studies provided by Khan and Watts (2009) who show a steep increase in conditional

conservatism around an increase in firms’ litigation risk.

< Insert Figure 5 here >

Figure 6 provides an indication for the shift in the distribution of C-Score. Two years

before the tax rate cut the distribution of C-Score is centered around its mean with a high

density. In the year of the tax rate cut the distribution of C-Score shifts to the right.

< Insert Figure 6 here >

I further perform the following multivariate tests. In a first step, I regress each of the

three conservatism measures on a dummy variable Event that takes value one if a large

tax rate cut is one year ahead and a vector of control variables X

Coni,t = γ0 + γ1 Eventk,t+1 + δ Xi,t + , (R1)

where Coni,t is one of the three conservatism measures C-Score, Skewness and Con-Acc

for firm i in year t. The subscript k indicates variables for country k. If firms’ level of con-

servatism is positively associated with a large tax rate cut in the next year (hypothesis 1),

then the coefficient γ1 should be positive and significant. I further construct a sub-sample

of firms in countries with high book-tax conformity (HighBT C) and low book-tax confor-

mity. HighBT C takes value one if the country ranks above the median of BT CRank in

17
the current year and zero otherwise. I estimate R1 separately for both sub-samples to test

hypothesis 2. If a positive association between the level of conservatism and a large tax

rate cut is stronger in countries with high book conformity, then the coefficient γ1 should

be larger in the HighBT C sub-sample. In line with previous research I control for firms’

Size as larger firms tend to be less conservative in accounting (Givoly and Hayn, 2007) as

well as profitability (Returns and Op. cashflow ). Furthermore, I expect firms with higher

degrees of managerial ownership measured by CEO shares to apply less conservative ac-

counting as these firms draw on more informal ways to decrease information asymmetries.

In line with Roychowdhury and Watts (2007) I also control for the market-to-book ra-

tio. Following Ahmed, Billings, Morton, and Stanford-Harris (2002) I expect Leverage

to affect conservatism who find that firms with higher conflicts between bondholders and

shareholders induce higher levels of conservatism. Sales growth may affect unconditional

conservatism due to increases in accruals (Ahmed and Duellman, 2007). R&D expenses

are usually directly expensed increasing unconditional conservative measures. Lastly, I in-

clude country and industry-year fixed effects to account for unobserved and time invariant

effects. I cluster all standard errors at the firm-level (Petersen, 2009).

< Insert Table 6 here >

Table 6 presents results of estimating equation (R1). In columns (1) to (4) I report

the effect of a major tax rate cut on firms’ conditional conservatism measured by C-Score

and a long-run measure over three years 3 yr. C-Score. The coefficient γ1 on Event is

positive and statistically significant (p < 0.001) indicating that firms’ level of conditional

accounting conservatism is increasing if a large tax rate cut is one year ahead. In contrast,

for Skewness (columns (5) and (6)) and Con-Acc (columns (7) and (8)) the coefficient γ1

on Event is not statistically significant at conventional levels providing some evidence that

future tax rate cuts have no effect on firms’ unconditional conservatism. Together, these

18
findings provide support for hypothesis 1 that firms’ level of conditional conservatism is

positively associated with future tax rate cuts.

< Insert Table 7 here >

In Table 7 I present results of estimating equation (R1) separately using a sub-sample of

firms facing high book-tax conformity and firms located in countries with low book-tax

conformity. The coefficient γ1 on Event is positive and statistically significant (p < 0.001)

in the sub-sample of firms with strong book-tax conformity (column (1)). In contrast,

the coefficient γ1 on Event is negative and statistically significant at the 5%-level in the

sub-sample of firms with low book-tax conformity (column (4)). In contrast, for Skewness

(columns (5) and (6)) the coefficient γ1 on Event is not statistically significant at con-

ventional levels (columns (2) and (5)). For Con-Acc γ1 is not statistically significant in

the high book-tax conformity sub-sample (column (3)), but positive and statistically sig-

nificant at the 10%-level in the low book-tax conformity sub-sample (column (6)). These

results give support for hypothesis 2 that the increase of conditional conservatism is con-

centrated in firms with high book-tax conformity. The previous results provide support for

both hypothesis 1 and 2. Whereas firms’ conditional conservatism is positively associated

with a large tax rate cut in the next year, unconditional conservatism is not. This effect,

however, is concentrated in firms facing strong book-tax conformity.

In a second test, I use a continuous measure for tax rate changes ∆CIT to test my

predictions. In particular, I regress the change of each conservatism measure (∆Con) on

the expected change in the corporate tax rate one year ahead (∆CIT ) and a vector of

control variables X. All variables are in first-differences (∆).

∆Coni,t = β0 + β1 ∆CITk,t+1 + δ ∆Xi,t + . (R2)

19
Positive values of ∆CIT indicate a tax rate cut. Therefore, if tax rate cuts in the next

period are positively associated with the conservatism level in the current year (hypothesis

1) the coefficient β1 should be positive and significant. This effect should be pronounced

in the high book-tax conformity sub-sample if hypothesis 2 holds.

Table 8 presents results of estimating equation (R2) for the full sample. For ∆C-

Score the coefficient β1 is positive and significant (p < 0.001) (column (1) and (2)). For

∆Con-Acc β1 is insignificant. For ∆Skewness β1 is positive and significant at the 10%-

level. These results corroborate hypothesis 1 that firms’ level of conditional conservatism

is positively associated with a reduction in the tax rate in the following year.

< Insert Table 8 here >

Table 9 presents the results of estimating equation (R2) using the high and low book-

tax conformity sub-sample. For C-Score, the coefficient β1 on ∆CIT is positive and

significant (p < 0.001) in the high book-tax conformity sub-sample and negative and

significant at the 1%-level in the low book-tax conformity sub-sample. This provides some

support for hypothesis 2 that a positive association between conditional conservatism in

the current year and a tax rate cut in the next year is especially pronounced for firms facing

high book-tax conformity. In contrast, β1 is insignificantly different from zero for Skewness

in the high book-tax conformity sub-sample and for Con-Acc in both sub-samples.

< Insert Table 9 here >

Together the results suggest that firms’ level of conditional conservatism is positively

associated with a tax rate cut in the next period. The positive association is especially

pronounced for firms facing high book-tax conformity. In contrast, the results suggest

that there is no positive association between unconditional conservatism and future tax

rate cuts.

20
4.1 Robustness tests

To corroborate the previous results I conduct the following additional robustness tests.

A potential concern using consolidated data could be that the data also includes income

and tax payments associated with foreign operations that are not affected by a tax rate

cut in the headquarters’ country. An increasing share of foreign income and tax payments

would then mitigate the firms’ incentive for increasing conservatism prior to a tax rate

cut in the home country. This concern would curb the previous results. To mitigate

this concern I run the previous tests in a sub-sample of domestic firms that cumulatively

meet the following requirements. Firstly, the firm holds at least 90% of its assets in the

headquarters’ country. Secondly, the firm earns at least 90% of its pre-tax income in the

headquarters’ country. Lastly, the firm has at least 90% of sales in the headquarters’

country. In total this leaves me with a sub-sample of domestic firms of 8,607 firm-year

observations for C-Score and all control variables. I estimate both equation (R1) and (R2)

again using the sub-sample of domestic firms.

< Insert Table 10 here >

Table 10 and 11 present results for the tests using the sub-sample of domestic firms.

All previous results also hold in the sub-sample of domestic firms. More importantly, the

coefficients γ1 and β1 are larger and statistically significant compared to the full sample

used in the previous tests indicating that the effect is larger for firms with the majority

of operations in the country in which the tax rate is reduced. For C-Score the coefficient

γ1 on Event increases from 0.247 using the full sample (Table 6, column (1)) to 0.697

(Table 10, column (1)) using the full domestic sub-sample. Note that the adjusted R2

almost doubles from 4.8% using the full sample to 9.5% using the full domestic sub-

sample suggesting that more of the variation in C-Score is explained by home-country

21
operations. Also the coefficient γ1 on Event increases from 0.816 using the full sample for

high book-tax conformity firms (Table 7, column (1)) to 1.201 using the domestic sub-

sample for high book-tax conformity firms (Table 10, column (4)) corroborating hypothesis

1. Furthermore, the coefficient γ1 on Event is insignificant for domestic and low book-tax

conformity firms (Table 10, column (7)) providing more evidence for hypothesis 2. I find

comparable results for estimating equation (R2) again in a sub-sample of domestic firms

(see Table 11).

< Insert Table 11 here >

The robustness tests provide some more evidence for hypothesis 1 and 2 and show that

the effect is especially pronounced for firms concentrating the majority of their operations

in the home country.

5 Conclusion

This study analyzes the relation between reductions in the corporate tax rate and firms’

conditional and unconditional accounting conservatism. In particular, I analyze whether

firms’ accounting conservatism is positively related to future tax rate cuts. Additionally,

I test if a positive relation between accounting conservatism and future tax rate cuts is

specifically pronounced when book and taxable income is strongly conformed. Because

timelier loss recognition shifts taxable income into the lower taxed future, firms have an

incentive to increase conservatism shortly before the tax rate is cut. If book-tax conformity

is strong then timelier loss recognition for book income also affects taxable income.

Using a sample of firms across 18 countries and 15 years (1995 to 2010), I find that

firms’ conditional conservatism is significantly positively related to future tax rate cuts if

book and taxable income is strongly conformed. In contrast there is no significant relation

between unconditional conservatism and future tax rate cuts. These results are especially

22
pronounced for firms that concentrate the majority of their operations in the country in

which the corporate tax rate is cut.

23
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Appendix

Figure 2: Corporate Tax Rates (Austria, Belgium, Denmark, Finland, France, Germany)
.6 .5
Corporate Tax Rate
.3 .4
.2

1990 1995 2000 2005 2010 2015

Year

Austria Belgium
Denmark Finland
France Germany

28
Figure 3: Corporate Tax Rates (Greece, Italy, Japan, Netherlands, Norway, New Zealand)

.6 .5
Corporate Tax Rate
.3 .4
.2

1990 1995 2000 2005 2010 2015

Year

Greece Italy
Japan Netherlands
Norway New Zealand

Figure 4: Corporate Tax Rates (Poland, Portugal, South Korea, Spain, Sweden, United
Kingdom)
.6 .5
Corporate Tax Rate
.3 .4
.2

1990 1995 2000 2005 2010 2015

Year

Poland Portugal
South Korea Spain
Sweden United Kingdom

29
 Figure 5: Accounting Conservatism over time around major tax rate cut

.4
.3
.2
.1
0

-3 -2 -1 0 1 2
Year relative to tax rate cut

C-Score Corporate Tax Rate

C-Score mean pre C-Score mean post

This figure shows the level of C-Score over time relative to the year the tax rate is cut. The
figure pools all observations from countries with a a large tax rate cut (≥ 5 percentage points
without any tax rate changes two years prior or after the tax rate cut). t = 0 indicates the year
in which the tax rate is cut.

Figure 6: Density of C-Score

2 1.5
Kernel Density
1 .5
0

-4 -2 0 2 4
x

Two years pre tax rate cut Year of tax rate cut

This figure shows the kernel density of C-Score two years prior a large tax rate cut (≥ 5
percentage points without any tax rate changes two years prior or after the tax rate cut) and in
the year of the tax rate cut. Observations from countries with a large tax rate cut are pooled.

30
 Table 1: Variable definitions

Variable Description
Accounting conservatism measures
C-Score First annual coefficients λi and σi are estimated with annual cross-sectional
regressions using regression model 9. λi and σi vary over time, but not across
firms. λi and σi are then used to estimate C-Score and G-Score by plugging
the coefficients into equations 8a and 8b. C-Score and G-Score vary over time
and across firms. For a detailed description see section 3.2 and Khan and
Watts (2009).
Con-Acc Net income before extraordinary items (Worldscope: WC01551) less cashflow
from operations (Worldscope: WC04201) plus depreciation expense (World-
scope: WC01151) deflated by average total assets (Worldscope: WC02999)
and averaged over the previous three years, multiplied by negative one. See
also: Ahmed and Duellman (2013).
Skewness Skewness is defined as the difference between cash flow and earnings skewness:
(x − µ)/3 σ 3 , where µ and σ are the mean and standard deviation of earnings
and cash flows over the last five years. See also: Givoly and Hayn (2000),
Ahmed and Duellman (2013).
Tax measures
∆CIT Corporate tax rate differential between year t and year t+1 (CITt −CITt +1).
Thus, positive values of ∆CIT indicate a decrease in the tax rate in the next
year.
Event Dummy variable set equal to one if the corporate tax rate drops at least by
5% from t to t + 1 and no changes in the corporate tax rate occur two years
before or after the tax rate drop.
BTCRank Scaled rankings of countries’ degree of book-tax conformity according to (At-
wood, Drake, and Myers, 2010). The ranks are based on the root mean-
squared error (RMSE) from the following model estimated by country-year:
CT Et = α + β1 P T BIt + β2 F orP T BI + β3 DIVt + t , where CT E is current
tax expense (WC01451), P T BI is pre-tax income (WC01401), F orP T BI is
foreign pre-tax income (WC07126) and DIV is dividends paid (WC04551).
CEO shares CEO shares is the percentage of closely held shares (Worldscope: WC08021)
in total outstanding shares (Worldscope: WC05301).
Domestic Dummy variable that takes value one if the firm reports less than 10 percent
of income (Worldscope: WC08741), sales (Worldscope: WC08731) and assets
(Worldscope: WC08736) as foreign (see also Lester and Langenmayr (2017),
Creal, Robinson, Rogers, and Zechman (2014), Osswald and Sureth-Sloane
(2017)).

31
 Table 1: Variable definitions continued

Variable Description
Control variables
Earnings Earnings is net income before extraordinary items (Worldscope: WC01551)
scaled by lagged market value of equity.
Leverage Leverage is defined as total debt (Worldscope: WC03255) deflated by market
value of equity.
MTB MTB is end-of-year market value of equity (Datastream: MV) deflated by
book value of equity (Worldscope: WC03501).
Op. cashflow Operating cashflow is the cashflow from operations (Worldscope: WC04201)
deflated by market value of equity.
R&D expense R&D expense is annual R&D expenses (Worldscope: WC01201) deflated by
market value of equity.
Returns Returns are annual Returns compounded from monthly Returns beginning
the fourth month after the firm’s fiscal year end.
Sales growth Sales growth is the percentage of annual growth in the firm’s total sales
(Worldscope: WC01001).
Size Size is the natural log of market value of equity. (Datastream: MV)

32
 Table 2: Book-tax conformity by country

Avg. RMSE
Avg. RMSE (Atwood et al. BTCRank
2010)
Japan 0.006 0.008 0.810
Portugal 0.006 n.a. 0.762
South Korea 0.007 n.a. 0.757
Poland 0.007 n.a. 0.746
Austria 0.008 0.009 0.731
Finland 0.008 0.010 0.681
Italy 0.008 0.010 0.646
Spain 0.008 0.008 0.625
Greece 0.010 0.014 0.576
Netherlands 0.010 0.009 0.525
New Zealand 0.010 0.013 0.488
Denmark 0.010 0.010 0.470
France 0.010 0.008 0.438
United Kingdom 0.012 0.010 0.301
Sweden 0.012 0.012 0.278
Norway 0.014 0.013 0.229
Germany 0.014 0.016 0.213
Belgium 0.014 0.014 0.192
This table presents the average book-tax conformity over the sample pe-
riod from 1995-2010 by country based on Atwood, Drake, and Myers (2010).
BTCRank is based on the root mean-squared error (RMSE) from the following
model estimated by country-year: CT Et = α + β1 P T BIt + β2 F orP T BI +
β3 DIVt + t . The average RMSE by (Atwood, Drake, and Myers, 2010) is
given for comparison (sample period 1992-2005). Higher (lower) RMSE in-
dicate lower (higher) book-tax conformity. BTCRank is the average rank of
each country over the whole sample period. Higher (lower) BTCRank indi-
cates higher (lower) book-tax conformity.

Table 3: Sample composition

Country N (Firms) N (Obs.) Country N (Firms) N (Obs.)

Austria 56 363 Netherlands 70 597
Belgium 87 660 Norway 90 644
Denmark 92 778 New Zealand 48 345
Finland 91 762 Poland 116 569
France 390 3,107 Portugal 31 201
Germany 383 2,700 South Korea 596 3,010
Greece 73 266 Spain 93 695
Italy 167 1,020 Sweden 176 1,356
Japan 1,587 15,802 United Kingdom 689 5,005
This table summarizes 37,880 firm-year observations across 18 countries in my
sample from 1995-2010.

33
 Table 4: Sample Selection

Step Description Observations

dropped remaining
1 All firms listed in Thomson Reuters’ Worldscope 168,227
Database from 1995-2010 for the 18 countries se-
lected
2 Drop observations with missing or market value 76,767 91,460
(MV) < $ 10.000
3 Drop observations with missing or negative book 8,731 82,729
value (WC01551)
4 Drop observations with missing or negative total as- 12 82,717
sets (WC02999)
5 Drop observations with missing sales (WC01001) 75 82,642
6 Drop observations with missing net income before 30 82,612
extraordinary items (WC01551)
7 Drop observations with missing total debt 84 82,528
(WC03255)
8 Drop observations with missing operating cash flow 847 81,681
(WC04201)
9 Drop observations with missing common shares out- 52 81,629
standing (WC05301)
10 Drop observations with missing closely held shares 28,427 53,202
(WC08021)
11 Drop observations with less than $1 of stock price 1,305 51,897
in line with Khan and Watts (2009)
12 Drop observations of all dependent and independent 14,017 37,880
variables not within 1st and 99th percentile of ob-
servations Becker, Jacob, and Jacob (2013)
This table presents the steps undertaken to retrieve the sample used. The final sample
comprises 37,880 firm-year observations for 4,835 firms. Table 3 presents an overview of
the distribution across countries.

34
 Table 5: Descriptive statistics

Variable N Mean St. Dev. Min. Q1 Median Q3 Max.

C-Score 37,880 0.062 0.794 -3.480 -0.064 0.023 0.116 4.612
Skewness 9,543 0.080 1.537 -5.298 -0.557 0.042 0.652 7.768
Con-Acc 26,844 0.004 0.019 -0.073 -0.004 0.003 0.013 0.089
Size 37,880 15.415 2.981 9.427 12.851 15.891 17.753 21.718
Returns 37,880 0.080 0.423 -1.174 -0.181 0.057 0.322 1.740
MTB 37,880 1.896 1.796 0.142 0.853 1.357 2.254 16.185
Leverage 37,880 0.835 1.522 0.000 0.082 0.342 0.903 17.011
Sales Growth 37,880 0.086 0.258 -0.635 -0.030 0.047 0.145 2.235
Op. Cashflow 37,880 0.146 0.182 -0.384 0.061 0.108 0.183 1.851
R&D expense 37,880 0.019 0.041 0.000 0.000 0.000 0.019 0.368
CEO shares 37,880 0.004 0.012 0.000 0.000 0.001 0.003 0.166
This table presents descriptive statistics of the main variables for 4,835 firms and 37,880 firm-year
observations over the sample period from 1995-2010. Observations for all continuous variables in the
1st and 99th percentile are eliminated. Variables are defined in Table 1.

35
 Table 6: Effect of major tax rate cuts on firms’ accounting conservatism

C-Score 3 yr. C-Score Skewness Con-Acc

(1) (2) (3) (4) (5) (6) (7) (8)
Event 0.247*** 0.247*** 0.178*** 0.181*** -0.041 -0.030 0.000 0.001
(0.056) (0.056) (0.037) (0.037) (0.118) (0.110) (0.001) (0.001)
Size -0.019*** -0.023*** -0.120*** -0.000
(0.003) (0.003) (0.014) (0.000)
Returns -0.010 -0.017** -0.669*** -0.000
(0.010) (0.007) (0.049) (0.000)
MTB -0.001 0.001 0.000 0.002***
(0.004) (0.003) (0.016) (0.000)
Leverage 0.005 0.000 0.108*** -0.001***
(0.007) (0.007) (0.021) (0.000)
Sales Growth -0.003 -0.005 -0.578*** -0.000

36
(0.021) (0.014) (0.106) (0.001)
Op. cashflow 0.048 0.017 0.791*** 0.021***
(0.034) (0.031) (0.199) (0.001)
R&D expense -0.038 -0.099 2.054*** 0.001
(0.071) (0.070) (0.494) (0.004)
CEO shares -0.824** -1.050*** -7.004*** -0.040**
(0.331) (0.333) (1.689) (0.016)
Observations 37,880 37,880 28,608 28,608 9,543 9,543 26,844 26,844
Adjusted R2 0.047 0.048 0.121 0.127 0.106 0.163 0.059 0.096
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010. All specifications are estimated
using OLS regressions. Specification (1) to (4) estimate the effect of major tax rate cuts (≥ 5 percentage points) on firms’ level of
conditional conservatism (C-Score) and long-run conditional conservatism (3 yr. C-Score). Specifications (5) to (8) estimate the effect of
major tax rate cuts (≥ 5%) on firms’ unconditional conservatism measured as Skewness and Con-Acc. All variable definitions are presented
in Table 1. All specifications include country and industry-year fixed effects. Robust standard errors clustered at the firm level are given
in parentheses. *, **, *** denote significance levels at the 10%, 5% and 1% level.
 Table 7: Effect of major tax rate cut across high and low book-tax conformity countries

High Book-Tax Conformity Low Book-Tax Conformity

C-Score Skewness Con-Acc C-Score Skewness Con-Acc
(1) (2) (3) (4) (5) (6)
Event 0.816*** -0.400 -0.001 -0.079** 0.073 0.003*
(0.156) (0.346) (0.001) (0.036) (0.118) (0.001)
Size -0.025*** -0.146*** -0.000 -0.013*** -0.104*** 0.000
(0.004) (0.025) (0.000) (0.003) (0.016) (0.000)
Returns -0.106*** -0.830*** 0.000 0.024 -0.580*** -0.001
(0.016) (0.086) (0.000) (0.015) (0.065) (0.001)
MTB 0.001 0.023 0.002*** 0.000 -0.013 0.002***
(0.006) (0.030) (0.000) (0.004) (0.020) (0.000)
Leverage -0.015** 0.145*** -0.001*** 0.043*** 0.103*** -0.001***
(0.006) (0.034) (0.000) (0.010) (0.026) (0.000)
Sales Growth 0.101*** -0.675*** -0.001 -0.056*** -0.465*** 0.001

37
(0.038) (0.170) (0.001) (0.020) (0.137) (0.001)
Op. cashflow 0.007 0.479 0.023*** 0.045 0.885*** 0.019***
(0.049) (0.332) (0.002) (0.044) (0.251) (0.002)
R&D expense -0.032 0.747 -0.010* 0.032 2.477*** 0.008
(0.124) (0.872) (0.006) (0.081) (0.580) (0.005)
CEO shares -1.671** -9.069*** -0.056** -0.350 -5.790*** -0.031
(0.811) (3.253) (0.024) (0.309) (1.868) (0.021)
Observations 19,892 3,844 13,681 17,988 5,699 13,163
Adjusted R2 0.096 0.097 0.125 0.121 0.163 0.082
Country fixed effects Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010. All
specifications are estimated using OLS regressions based on estimation R1 using a sub-sample of high book-
tax conformity and low book-tax conformity countries. High book-tax conformity is defined as observations
above the median of BTCRank. Specification (1) to (4) estimate the effect of major tax rate cuts (≥ 5
percentage points) on firms’ level of conservatism (C-Score, Skewness, Con-Acc) for firm-year observations
in high book-tax conformity countries. Specification (5) to (8) estimate the effect of major tax rate cuts (≥ 5
percentage points) on firms’ level of conservatism (C-Score, Skewness, Con-Acc) for firm-year observations
in low book-tax conformity countries. All variable definitions are presented in Table 1. All specifications
include country and industry-year fixed effects. Robust standard errors clustered at the firm level are given
in parentheses. *, **, *** denote significance levels at the 10%, 5% and 1% level.
 Table 8: Effect of corporate tax rate changes on firms’ accounting conservatism

∆ C-Score ∆ 3 yr. C-Score ∆ Skewness ∆ Con-Acc

(1) (2) (3) (4) (5) (6) (7) (8)
∆CIT 2.466*** 2.472*** 0.324 0.300 0.678 2.937* 0.006 0.007
(0.379) (0.382) (0.206) (0.209) (1.908) (1.720) (0.007) (0.006)
∆Size 0.034 0.030*** -1.067*** -0.001*
(0.026) (0.009) (0.115) (0.001)
∆Returns -0.002 0.001 -0.427*** -0.000
(0.013) (0.004) (0.047) (0.000)
∆MTB 0.002 -0.004 0.102** 0.002***
(0.010) (0.003) (0.041) (0.000)
∆Leverage 0.039** 0.015** 0.097** -0.001***
(0.018) (0.006) (0.049) (0.000)
∆Sales Growth -0.013 -0.005 -0.267** -0.001*

38
(0.032) (0.011) (0.107) (0.000)
∆Op. cashflow 0.000 -0.030 2.985*** 0.017***
(0.060) (0.022) (0.319) (0.001)
∆R&D expense 0.507** 0.154* 0.092 0.002
(0.213) (0.088) (1.388) (0.003)
∆CEO shares -1.616 -0.166 -4.316 -0.052**
(3.731) (0.995) (6.720) (0.024)
Observations 32,158 32,158 24,043 24,043 7,238 7,238 22,262 22,262
Adjusted R2 0.016 0.016 0.034 0.035 0.051 0.144 0.019 0.049
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010. All specifications are estimated
using OLS regressions in first differences (∆) based on estimation R2. Specification (1) to (4) estimate the effect of tax rate changes
on firms’ level of conditional conservatism (C-Score) and long-run conditional conservatism (3 yr. C-Score). Specifications (5) to (8)
estimate the effect of tax rate changes on firms’ unconditional conservatism measured as Skewness and Con-Acc. All variable definitions
are presented in Table 1. All specifications include country and industry-year fixed effects. Robust standard errors clustered at the firm
level are given in parentheses. *, **, *** denote significance levels at the 10%, 5% and 1% level.
 Table 9: Effect of corporate tax rate changes across high and low book-tax conformity countries

High Book-Tax Conformity Low Book-Tax Conformity

C-Score Skewness Con-Acc C-Score Skewness Con-Acc
(1) (2) (3) (4) (5) (6)
∆CIT 8.758*** -0.377 0.002 -1.381*** 3.818** 0.009
(1.514) (4.783) (0.017) (0.443) (1.860) (0.009)
∆Size 0.027 -1.168*** -0.000 0.025 -1.022*** -0.001*
(0.041) (0.206) (0.001) (0.033) (0.136) (0.001)
∆Returns -0.077*** -0.454*** -0.000 0.011 -0.378*** 0.000
(0.020) (0.075) (0.000) (0.018) (0.064) (0.000)
∆MTB -0.011 0.143** 0.001*** 0.015 0.080 0.002***
(0.015) (0.064) (0.000) (0.012) (0.052) (0.000)
∆Leverage 0.047** 0.116 -0.001*** 0.042 0.111* -0.001*
(0.020) (0.086) (0.000) (0.027) (0.061) (0.000)
∆Sales Growth 0.009 -0.508*** -0.001 -0.031 -0.120 -0.001

39
(0.053) (0.185) (0.001) (0.031) (0.131) (0.001)
∆Op. cashflow -0.037 2.427*** 0.017*** 0.142* 3.219*** 0.017***
(0.087) (0.580) (0.001) (0.074) (0.383) (0.001)
∆R&D expense 0.700 1.806 -0.001 0.391* -0.069 0.003
(0.448) (3.075) (0.006) (0.210) (1.524) (0.004)
∆CEO shares -5.320 -11.621 -0.048* 1.229 2.168 -0.054
(5.983) (11.642) (0.029) (1.987) (7.597) (0.044)
Observations 16,896 2,571 11,163 15,262 4,667 11,099
Adjusted R2 0.054 0.121 0.053 0.092 0.149 0.054
Country fixed effects Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010. All
specifications are estimated using OLS regressions based on estimation R2 using a sub-sample of high book-
tax conformity and low book-tax conformity countries. High book-tax conformity is defined as observations
above the median of BTCRank. Specification (1) to (4) estimate the effect of tax rate changes on firms’
level of conservatism (C-Score, Skewness, Con-Acc) for firm-year observations in high book-tax conformity
countries. Specification (5) to (8) estimate the effect of tax rate changes on firms’ level of conservatism
(C-Score, Skewness, Con-Acc) for firm-year observations in low book-tax conformity countries. All variable
definitions are presented in Table 1. All specifications include country and industry-year fixed effects. Robust
standard errors clustered at the firm level are given in parentheses. *, **, *** denote significance levels at
the 10%, 5% and 1% level.
 Table 10: Effect of major tax rate cuts on domestic firms’ accounting conservatism

Full Domestic Sample High Book-Tax Conformity Low Book-Tax Conformity

C-Score Skewness Con-Acc C-Score Skewness Con-Acc C-Score Skewness Con-Acc
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Event 0.697*** -0.326 -0.002 1.201*** -0.122 -0.012*** -0.048 -0.163 -0.001
(0.205) (0.852) (0.004) (0.409) (1.203) (0.004) (0.081) (0.398) (0.007)
Size -0.008* -0.117*** -0.000 -0.013** -0.212*** -0.000 -0.006 -0.069 -0.000
(0.005) (0.038) (0.000) (0.006) (0.062) (0.000) (0.006) (0.045) (0.000)
Returns -0.035* -0.745*** -0.001 -0.107*** -0.710*** -0.000 0.062* -0.693*** -0.002*
(0.020) (0.152) (0.001) (0.025) (0.230) (0.001) (0.034) (0.220) (0.001)
MTB 0.009* 0.020 0.002*** 0.017*** 0.041 0.001*** -0.001 -0.014 0.003***
(0.005) (0.050) (0.000) (0.006) (0.068) (0.000) (0.006) (0.071) (0.000)
Leverage -0.012 0.127*** -0.000 -0.026*** 0.177** -0.001*** 0.007 0.112 0.000
(0.011) (0.048) (0.000) (0.009) (0.085) (0.000) (0.018) (0.071) (0.000)
Sales Growth -0.056 -0.201 0.004** -0.041 -0.669 0.001 -0.072* 0.224 0.005**

40
(0.046) (0.283) (0.002) (0.063) (0.543) (0.003) (0.042) (0.305) (0.002)
Op. cashflow 0.008 1.912*** 0.023*** 0.131 -0.578 0.026*** -0.125 2.811*** 0.020***
(0.068) (0.505) (0.003) (0.080) (0.997) (0.003) (0.092) (0.646) (0.005)
R&D expense -0.084 -1.235 -0.024** -0.090 -3.415 -0.031*** 0.068 0.682 -0.022
(0.088) (1.334) (0.010) (0.091) (2.678) (0.009) (0.150) (1.927) (0.019)
CEO shares -0.168 -8.139* -0.017 -0.783 -29.465** -0.104 0.959 -2.105 0.016
(0.982) (4.642) (0.065) (2.128) (12.904) (0.113) (0.885) (6.955) (0.083)
Observations 8,607 2,018 5,805 5,546 855 3,517 3,061 1,163 2,288
Adjusted R2 0.095 0.134 0.128 0.219 0.058 0.103 0.153 0.163 0.157
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010 for domestic firms. All specifications are
estimated using OLS regressions based on estimation R1 using a sub-sample of high book-tax conformity and low book-tax conformity countries. High
book-tax conformity is defined as observations above the median of BTCRank. Specification (1) to (3) estimate the effect of major tax rate cuts (≥ 5
percentage points) on firms’ level of conservatism (C-Score, Skewness, Con-Acc) for the full sample of domestic firms. Specification (4) to (6) present
results for the estimation in a sub-sample of domestic firms with high book-tax conformity. Specification (7) to (9) present results for the estimation
in a sub-sample of domestic firms with low book-tax conformity. All variable definitions are presented in Table 1. All specifications include country
and industry-year fixed effects. Robust standard errors clustered at the firm level are given in parentheses. *, **, *** denote significance levels at the
10%, 5% and 1% level.
 Table 11: Effect of corporate tax rate changes on domestic firms’ accounting conservatism

Full Domestic Sample High Book-Tax Conformity Low Book-Tax Conformity

C-Score Skewness Con-Acc C-Score Skewness Con-Acc C-Score Skewness Con-Acc
(1) (2) (3) (4) (5) (6) (7) (8) (9)
∆CIT 1.612 1.394 -0.009 6.413** -0.937 -0.169** -0.923 -0.721 0.025
(0.983) (7.011) (0.023) (3.068) (10.530) (0.080) (1.510) (7.643) (0.036)
∆Size 0.094** -1.123*** -0.002** 0.112* -2.067*** -0.001 0.096 -0.832*** -0.003*
(0.045) (0.272) (0.001) (0.059) (0.584) (0.001) (0.060) (0.306) (0.002)
∆Returns -0.040* -0.453*** -0.000 -0.083*** -0.468** -0.001 0.020 -0.380** 0.001
(0.023) (0.137) (0.000) (0.027) (0.195) (0.001) (0.044) (0.187) (0.001)
∆MTB 0.020 0.204* 0.002*** 0.001 0.515** 0.002*** 0.046** 0.141 0.002***
(0.014) (0.106) (0.000) (0.017) (0.215) (0.000) (0.020) (0.144) (0.000)
∆Leverage -0.001 0.201* -0.001** 0.017 0.073 -0.001* -0.025 0.283 -0.001
(0.036) (0.119) (0.000) (0.032) (0.173) (0.000) (0.041) (0.183) (0.001)
∆Sales Growth -0.007 -0.161 -0.001 0.034 -0.061 0.000 -0.074 -0.215 -0.001

41
(0.070) (0.261) (0.001) (0.105) (0.382) (0.002) (0.063) (0.333) (0.001)
∆Op. cashflow 0.055 4.064*** 0.022*** 0.126 3.516*** 0.023*** 0.109 4.543*** 0.021***
(0.094) (0.741) (0.002) (0.103) (1.024) (0.003) (0.134) (0.972) (0.003)
∆R&D expense 0.417* 8.925 -0.008 0.159 -2.960 0.005 0.776** 11.103* -0.025
(0.249) (5.471) (0.011) (0.230) (12.553) (0.011) (0.382) (6.131) (0.021)
∆CEO shares -3.411 -26.487 -0.072 -1.181 -150.351*** -0.164 -1.336 25.735 -0.017
(5.654) (40.823) (0.102) (9.567) (44.019) (0.166) (6.264) (23.378) (0.130)
Observations 7,187 1,550 4,671 4,559 557 2,700 2,628 993 1,971
Adjusted R2 0.056 0.124 0.082 0.186 0.114 0.077 0.152 0.128 0.095
Country fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
Industry-year fixed effects Yes Yes Yes Yes Yes Yes Yes Yes Yes
This table presents regression results on firms’ accounting conservatism over the sample period 1995-2010 for domestic firms. All specifications are
estimated using OLS regressions based on estimation R1 using a sub-sample of high book-tax conformity and low book-tax conformity countries. High
book-tax conformity is defined as observations above the median of BTCRank. Specification (1) to (3) estimate the effect of major tax rate cuts (≥ 5
percentage points) on firms’ level of conservatism (C-Score, Skewness, Con-Acc) for the full sample of domestic firms. Specification (4) to (6) present
results for the estimation in a sub-sample of domestic firms with high book-tax conformity. Specification (7) to (9) present results for the estimation
in a sub-sample of domestic firms with low book-tax conformity. All variable definitions are presented in Table 1. All specifications include country
and industry-year fixed effects. Robust standard errors clustered at the firm level are given in parentheses. *, **, *** denote significance levels at the
10%, 5% and 1% level.