The nexus between aggressive tax planning and earnings management in different political systems and the moderating role of corporate governance

The purpose of this paper is to explore the relationship between aggressive tax planning and earnings management in European listed companies. In addition, this study compares different political systems of the sample European countries when studying this relationship. Further, this study examines the moderating role of governance characteristics on the relationship between aggressive tax planning and earnings management. We use panel data models based on data of 105 companies listed on the EURONEXT 100 and NEXT 150 during the period 2011 to 2018. We also apply additional analysis and a robustness check to alleviate the endogeneity concern. The results show that there is a significant positive relationship between aggressive tax planning and earnings management. The results also reveal that firms which tend to use earnings management practices have a lower effective tax rate (ETR). This relationship is more pronounced in countries with a Presidential system compared to Parliamentary or Quasiparliamentary system countries. Also, the findings relating to the moderating role of governance variables show that the interaction between each of board size and board independence with the effective tax rate is negative and significant. These findings suggest that the board plays an effective role in weakening the relationship between the effective tax rate and earnings management. That is, more members on the board of directors and more independent directors on the board along with the effective tax rate deters earnings management practices. Future research may extend this work by covering other attributes of corporate transparency including accounting conservatism and considering other proxies of aggressive tax planning. The findings help corporate stakeholders to better understand the relationship between aggressive tax planning and earnings management by highlighting the role of the political system and board governance and take the necessary actions to reduce these behaviors.