AN INVESTIGATION OF EARNINGS MANAGEMENT AND ITS EFFECT ON CORPORATE TAX AVOIDANCE

CHAPTER ONE

INTRODUCTION

1. Background of the study

Companies see taxes as an onerous expenditure that diminishes the potential profit to be made. The primary objective of every corporation is to optimise the well-being of its shareholders, which may lead some corporations to explore methods of minimising their tax liabilities. Due to variations in the underlying principles of profit generation as dictated by accounting and tax regulations, the tax payments made by different organisations will change (Ain, dan & Subardjo, 2015). Companies might engage in earnings management as a means to evade taxes. Tax avoidance sometimes entails detecting discrepancies between existing taxation legislation and the current Financial Accounting Standards Guidelines, in order to reduce tax payments. Halioui, Nizwa, Souhir, & Abdelaziz (2016) assert that enterprises experiencing a temporary increase in their tax liability are more likely to consistently generate pre-tax profits.

The corporate governance policies of a corporation have an impact on how the firm meets its tax responsibilities, and these policies might potentially be used for tax manipulation purposes. Amidu, Coffie & Acquah (2019) elucidate the significance of examining the interplay between corporate governance and tax regimes. The study done by Amidu, Yorke, and Harvey (2016) examines the impact of tax strategies on corporate governance. It suggests that companies with effective corporate governance procedures are more likely to comply with their tax duties. Corporate governance is crucial for any firm. In order to bolster these corporate governance processes, the Indonesian government mandates that all firms must appoint independent commissioners. One of the goals of corporate governance procedures is to reduce the opportunistic actions of management, especially in relation to taxation.

The existing literature has shown a strong correlation between earnings management and tax evasion practices (Bunaca & Nurdayadi, 2019). There is an argument that tax avoidance and profits manipulation have similar tactics. This means that managers who are trying to avoid taxes might also use these strategies to control earnings for their own personal gain (Gatsi, Anipa, Gadzo & Ameyibor, 2016). According to Irianto, Sudibyo, and Wafirli (2017), tax evasion may be characterised as the movement of value from the government to shareholders. It is attributed to have the effect of increasing value and being advantageous to shareholders. Tax expenditures sometimes constitute a substantial proportion of a company's earnings and provide substantial potential hazards (Kapoutso, Tzovas & Chelevas, 2015). In addition to the substantial expenses associated with compliance, such as hiring tax specialists and completing tax returns, the company's shareholders bear the weight of the tax via diminished dividends (Koh & Lee, 2015). Therefore, implementing a CTA is considered advantageous to shareholders since it reduces tax payments, resulting in a surplus of cash flow that may be used for further dividends or invested in lucrative ventures. Alternatively, EM might be seen as a redistribution of wealth from shareholders to management. The reason for this is that the monies that were redirected might have been used for lucrative investments or distributed as dividends (MacCarthy & Ahulu, 2019). As a result, companies linked to emerging markets have been shown to possess reduced market values. What will be the eventual effect on the firm's worth when there are complimentary technologies between earning management (EM) and corporation tax avoidance (CTA) and they interact with each other? Therefore, the researcher sought to fill the gaps in literature by investigating earnings management and its effect on corporate tax avoidance.

1. 1. Statement of the problem

Earnings management is the deliberate manipulation of a company's financial statements with the aim of achieving certain goals, such as fulfilling earnings targets, influencing stock prices, or getting favourable financing conditions. Although a certain level of profits management is seen acceptable in the corporate world, engaging in excessive or fraudulent manipulation might result in various adverse outcomes (Koh & Lee, 2015). It is crucial to acknowledge that while many tactics of manipulating profits may be within the bounds of the law, there are others that transgress both ethical and legal limits, resulting in deceitful financial reporting. Authorities and regulators are diligent in detecting and punishing enterprises that participate in deceitful practices, particularly those intended to evade taxes. Robust corporate governance, clear transparency, and strict adherence to accounting standards are crucial for maintaining the integrity of financial reporting and ensuring that tax evasion remains within the confines of the law and ethical principles. Companies should exercise prudence when participating in assertive earnings management tactics that may invite regulatory attention and legal repercussions (Koh & Lee, 2015). The issues pertaining to profits management and their possible impact on corporate tax evasion might have significant consequences. Hence, the need to investigate earnings management and its effect on corporate tax avoidance.

1.3 Objective of the study

The broad objective of the study is to investigate earnings management and its effect on corporate tax avoidance. The specific objectives is as follows;

1. Examine the reason for earnings managemen in a firm

2. Assess the effect of earnings management on corporate tax avoidance of a firm

3. Find out the relationship between earnings management (EM) and corporate tax avoidance (CTA).

1.4 Research Hypothesis

The hypotheses will guide the study

H0: Earnings management does not have an effect on corporate tax avoidance

Ha: Earnings management have an effect on corporate tax avoidance

1.5 Significance of the study

The findings of the study is significant to business organizations in the following ways:

Smoothed Earnings: Companies may engage in earnings management to smooth out fluctuations in their reported earnings. This can help present a more stable and predictable financial performance, which may be attractive to investors and creditors.

Incentive Alignment: in some cases, management might adjust earnings to align with the company's long-term strategic goals, incentivizing employees and ensuring the company meets performance targets.

Also, the findings of the study is significant to the academic community as it will contribute to the existing literature.

1.6 Scope of the study

The study focuses on the earnings management and its effect on corporate tax avoidance. Hence, the study is delimited to Dangote refinary, Obajana, Lokoja, Kogi State.

1.7 Limitation of the study

Like in every human endeavour, the researchers encountered slight constraints while carrying out the study. Insufficient funds tend to impede the efficiency of the researcher in sourcing for the relevant materials, literature, or information and in the process of data collection (internet, questionnaire, and interview), which is why the researcher resorted to a moderate choice of sample size. More so, the researcher will simultaneously engage in this study with other academic work. As a result, the amount of time spent on research will be reduced.

1.8 Definition of terms

Earning management: the strategic manipulation of a company's financial statements to present a more favorable picture of its financial performance and position than is actually the case.

Tax avoidance: the use of legal methods to minimize the amount of income tax owed by an individual or a business.