A Tax Regime to Reduce Cash Hoarding and Tax-induced Earnings Management: Evidence from Korea

To boosts the national economy, the Korean government introduced a new tax policy, adding taxes on earnings while providing tax reductions for wage increase, dividends, and investments. This study investigates whether firms evade the tax by manipulating their earnings. Analyzing data from 2012 to 2017 with difference-in-differences (DiD) regressions, we find that this coercive policy failed, as firms lowered earnings to avoid taxes. Real earnings management methods, primarily among financially constrained firms, were used instead of accrual-based methods. However, in the post period after 2018 when the tax policy continued, firms increased wages, dividends, and investments without managing earnings. Evidence shows that though the tax policy failed in the short-term due to earnings management, it proves effective in the long term. Our study contributes to the earnings management literature and provides valuable insights for tax policymakers.