2013 Cambridge Business & Economics Conference
ISBN : 9780974211428
Are Taxes a Determinant Factor in Earnings Management Behavior? –
Empirical Results From Brazilian Insurance Market.
ABSTRACT
Earnings management is a special issue in accounting theory, and the main impact of
the practice is the creation of biases in financial statements. More specifically,
earnings management affect accounting profits, and consecutively affect stakeholders
in their decisions. According to the specialized literature, earnings management is a
practice considered feasible by companies when they glimpse incentives to perform it,
and incentives to the practice can be established by different reasons, so one may
reasonably believe that enforcements rules of the environment is a special stimulus to
the practice. As an example, unequal tax-rules between economic sectors can
stimulate the practice of earnings management. So, our purpose is to verify if the legal
enforcement by the government authorities created incentives to the earnings
management in Brazil. To test the hypothesis, we selected a sample-data composed by
Brazilian insurance companies, since this sector suffered a considerable increase in
the income-taxes rate in 2008, moving the global rate from 34% to 40% of the
accounting profit. Our sample consisted in 1.536 firms-years observations, in 16
quarters between 2007 and 2009. The utilization of this specific group had other
important motive: according to Brazilian tax regulatory system, technical accruals
from insurance companies can be considered deductible from income taxes. To
consider the situation, we created a panel data model with changes in the level of the
specified accruals during the selected time and included control variables for a better
model specification. The results showed a significant relationship between the
increased tax rates and the measure of the specified accruals, showing evidences of
earnings management behavior in this sector.
Key-words: (I) Earnings Management; (II) Tax Determinants; (III) Brazilian
Insurance Market.
Authors:
Eduardo da Silva Flores
Álvares Penteado Business School – São Paulo, Brazil.
Héber Pessoa da Silveira
Álvares Penteado Business School – São Paulo, Brazil.
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1.
ISBN : 9780974211428
INTRODUCTION
Earnings management (EM) is a special issue for accounting researchers. So
many authors investigate the effects of this practice in the creation of biases in
financial statements, more specifically in profits (e.g. HEPWORTH, 1953; JONES,
1991, DECHOW; SLOAN; SWEENEY, 1995; DECHOW et al, 2011). According to
the Healy and Wahlen (1999) earnings management has been defined as the use of
judgment in financial reporting and in structuring transactions to alter financial
reports to either mislead some stakeholders about the underlying economic
performance of the company or to influence contractual outcomes that depend on
reported accounting numbers.
Doupinik (2008) show that prior researches has investigated a variety of
incentives for EM: stock prices, income targets, less variable incomes reports and
many other factors that stimulates managers to affect results with artificial accounting
entries. One can logically expect that the EM only happens in firms where the
perceived benefits are higher than the perceived risks incurred in this kind of
accounting manipulation. Watts and Zimmerman (1978) established three general
lines associated with motivational factors that tends to boosts the companies for the
earnings management behavior: (I) capital markets; (II) regulatory costs; and (III)
benefits to the accounting performance. Each one of these motivational factors can be
interpreted by different points view, creating a multiple perspective about the main
reasons that lead firms to the practice of EM. More specifically, referring to the
incentives of regulatory costs, it is plausible to believe that the tax environment in
which a firm is involved is a strong stimulus for increasing the discretionary judgment
by managers in financial statements. Dealing with the involuntary obligation of taxes
payments, firms usually seek alternative ways to reduced taxes applied to its core
business, even running the risk of a reduction in the quality of its accounting
measurement (e.g. CHEN; DALEY, 1996; BEATY; HARRIS, 1998;
BADERTSCHER et al, 2006; DESAI; DHARMAPALA, 2009).
In Brazilian taxation system one finds different treatments for companies due
to various issues, such as firm size, capital structure or business sector. In this last
one, for example, we can mention the elevation of the EBIT tax rate to financial
companies occurred in 2008, when this rate increased from 34% to 40% of EBIT for
those firms. It is reasonable to believe that this situation boosted the firms to compute
lower profits, trying to reduce their income taxes.
In this context, the objective of this paper can be summarized as follows: are
taxes a determinant factor in earnings management behavior? To check the
argument we selected firms present in Brazilian insurance market, because, according
to the Law 3.000/99, these companies can subtract of their income taxes basis the
values of technical liabilities representing the risks assumed by these organizations in
the private insurance industry. A more detailed methodology is described in section 3.
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The structure of the paper is as follow: Section 2 brings background and
hypothesis development, where we do the literature review and establish the
constructs; Section 3 describes methodological aspects such as strategic approach
applied for the study, sample details and methods; Section 4 brings results and
comments; Section 5 concludes with a summary of the main results and some
suggestions for future researches.
2.
BACKGROUND AND HYPHOTESIS DEVELOPMENT
2.1
Earnings management definitions
Financial statements commonly subsidizes stakeholders during decision
making about investments and allocation of financial resources and creation of
scenarios, but at the same time they suffer the influence and pressures that arise from
internal and external forces of the organizations. In other words, managers frequently
have stimulus to creates distortions in accounting numbers, sometimes seeking to
deceive stakeholders. Following Healy and Wahlen (1999, p. 368):
Earnings management occurs when managers use judgment in financial reporting and
in structuring transactions to alter financial reports to either mislead some
stakeholders about the underlying economic performance of the company or to
influence contractual outcomes that depend on reported accounting numbers.
Earnings management occurs basically when managers use judgment in
financial transactions and make operations that alters the financial results reported in
order to mislead other stakeholders about the company’s performance or to influence
contracts that depends on accounting numbers (Healy; Wahlen, 1999). Scott (2003)
and McKee (2005) characterized earnings management as the decision facing the
accounting information in order to obtain specifics gains and even maintaining
unrealistic stable and predictable financial results. Ewert and Wagenhofer (2005)
mention that this behavior can be developed in case of changes that affect the timing
of recognition of certain items in Accounting and/or in structuring operations aimed
solely to alter financial results. As an example, the formation of specifics purposes
enterprises (SPEs) for the sole purpose of recording losses or gains. Roychowdhury
(2006) highlights that in both cases the operational earnings management practice is
encouraged by managers.
According to Watts and Zimmerman (1978) earnings management have
occurred as a function of the three main perspectives shown below (Frame 1):
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Incentives to
EM
Description
ISBN : 9780974211428
Prior studies
Capital market
motivations
Firms use accounting information
to create unrealistic expectations
about stock returns thus receiving
better resources from capital
markets.
DeAngelo (1988); Perry and Williams
(1994); Erickson and Wang (1998); Dechow,
Sloan and Sweeney (1995.
Contracting
motivations
Firms use account numbers to
regulate contractual deals.
Dechow and Sloan (1991); DeFond and
Jiambalvo (1994); Holthausen et al (1995).
Regulatory
motivations
The use of EM is more likely to
happen when organizations are
submitted to specifics regulations.
Jones (1991); Cahan (1992); Gaver and
Paterson (2003); Albornoz and Illueca
(2005).
Frame 1 – Incentives to Earnings Management
These incentives can be combined and create new reasons to improve the EM
in financial statements. More specifically in regulatory motivations, managers have a
special intention to practice some kind of manipulation, because the impacts of
changes in rules generally affect companies financial plans and budgets.
It’s important to mention that all firms account information hold some kind of
discretionary judgment enforced by managers, but not all the judgments are used to
create informational mistakes or to mislead stakeholders. In other words, it is expected
that earnings have part of its numbers influenced by the experience and know-how of
managers and counters about their business. For this reason it is really difficult to be
sure of when a firm or a group of companies is practicing earnings manipulation or not.
Note also that although the EM impact the quality of published results, the
accounting decisions in this context should not be always seen as fraudulent behavior,
once earnings management occurs primarily in the context of legality, although there is
sometimes only a tenuous distinction or barrier with illegal practices.
2.2
Increase in income taxes applied to Brazilian financial sector
The Brazilian tax scenario has been subject of many discussions regarding
controversial – and sometimes difficult to understand – issues. Even legislation and
auditing authorities sometimes find it difficult to understand and interpret the large
amount of taxation laws and standards. Brazilian law determine that the process of
collecting contributions, taxes and fees is enforced by government to achieve the
common good (CARRAZA, 2003), then taxes can only be created and charged to
establish some kind of harmony with taxpayers (SILVA, 2010). The argument can be
shown, for example, by the income taxes formation in Brazil. In this country taxes
applied over firms earnings are shared in two kinds of duties: the first is a tax (Income
Taxes) and the second a tribute called “Contribuição Social Sobre o Lucro Líquido”
(Social Contribution over Net Incomes in free translation) from now on cited as
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“CSLL”. These two taxes are levied on profits, and Brazilian tax law distinguishes
between both. Regarding specifically to CSLL, according to Alencar, Pereira and
Rezende (2010, p.127):
The creation of the CSLL was established in art. 195 of the Constitution, which deals
with contributions to fund social security. The CSLL is a social contribution, of
Union's competence, levied on legal entities included in this group those that are
equivalent to the legal person for purposes of taxation from income tax.
The net income is the starting point in the calculation of income tax, and after
being adjusted with the addition and subtraction of the relevant expenses and/or
incomes (deemed deductible or not), the income, now a form of profit, is used as the
basis for calculating CSLL. Gallo, Pereira and Reis (2010, p.35) point out that "[...]
his determination is similar to income tax, hence, the legal entity that opt for the
calculation of income tax by a regime, automatically also opt for the same to calculate
the CSLL".
January 3, 2008 was the date of promulgation of the Medida Provisória (a
legal artifact existing in Brazilian legal environment) 413 (MP 413) subsequently
converted into Law 11,427, which, among other guidelines and through its Article 17,
altered the CSLL charged to financial institutions and similar companies, which
increased from 9% of the calculation basis cited above to the current 15%.
Another important point to be emphasized with respect to a characteristic of
the Brazilian tax system is the “principle of precedence”, which is materialized
through the drafting of paragraph c of section III of article. 150 of the Federal
Constitution, as follows:
Article 150. Notwithstanding other guarantees ensured to the taxpayer, it is forbidden
for the Union, States, the Federal District and Municipalities: [...]
III - tributes [...]
c) within ninety days of the date of publication of the law which instituted or
increased [the tribute]; (Included by Constitutional Amendment No 42, 19.12.2003).
BRAZIL (1988).
Thus, the financial impact of the increment provided in CSLL rate only began
to affect the group of firms mentioned above around May 2008, since ninety days
from the date of publication of MP 413 would be up in April. However, as the
payment of income tax and social contribution happen on the last day of the month
following its determination, the first payment based on redetermination occurred only
on May 30, 2008. It is relevant to us to mention this characteristic once this situation
motivated the construction of a database consisting of quarterly information provided
from financial statements. More details are seen in section 3.
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2.3
Determinants of environmental
management behavior
ISBN : 9780974211428
tax
practices
in
earnings
An early work on earnings management was done by Hepworth (1953), in
which he sought to verify the adoption of accounting standards that would allow the
reduction of the firms accounting profits, thus performing the reduction of tax
payment. Goulart (2007, p.48) notes that "companies with very high profits relative to
other sectors may find themselves encouraged to accounting practices that reduce
their results in order not to draw too much attention from the collecting agencies,
which may propose taxes increases".
Chen and Daley (1996) analyzed the existence of earnings management in the
Canadian financial industry from 1977 to 1987, period in which those firms had
incentives to perform practices that would allow certain tax benefits. Although they
have not achieved robust evidence in their research, the authors highlighted that there
were some evidence of the practice.
Beatty and Harris (1998) compared the effects of taxes, agency costs and
information asymmetry, involving earnings management between public and private
banks. Their results indicated that public banks have tended to manage their results
more than private banks, and the authors said it was a consistent finding among
previous research, which indicated that companies of this nature tend to practice more
earning management in order to sustain better accounting performances.
Corrar, Martins and Paulo (2007) conducted a study in order to check if the
analysis of deferred tax effectively increased earnings management in econometric
models. They developed a survey among some economic sectors in Brazil, using
more specifically two econometric models which they modified: Jones model (MJM)
and Kang and Sivaramakrishnan (KS) model, both developed in 1995. The results
showed that the analysis of the deferred tax credit has not improved significantly the
quality of the technics. The authors emphasized that this result was probably due to
the condition that such models were developed and where they were set up, in this
case, the North American economy.
Han and Wang (1998) investigated, along the Gulf War, that U.S. companies
producing fuels tended to manage their results due to a tax lien applied to the price of
these products, which was above parameters of past years. The authors found the
existence of abnormal behavior in the profit account of these companies, which was
interpreted as a strong indication of earnings management.
Rodrigues (2006) checked the use of technical accruals of Brazilian insurance
companies, in order to reduce taxable income in periods of higher profits. It was
found evidence of significant achievement of the practice when the firms exceed
specifics standard numbers. Another important finding was the reversion of the
technical accruals when profits were lower than this limits, evidencing some kind of
manipulation to improve or worsen accounting results.
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The present study follows the line of research which considers that questions
of tax environmental can create strong incentives for the practice of earnings
management, once one believes that managers search for benefits of mitigating taxes
payment through the process of recognition and accounting measurement, therefore
affecting the informational quality of financial reports. The practical consequence of
this perspective is the accentuation of informational asymmetry between users of
financial statements, as shown in FIGURE 1:
FIGURE 1 – Tax determinants in earnings management approach.
Conjugating the object of this research with the background developed above,
we established the following hypotheses, which were tested through empirical
procedures detailed in Section 3:
Hypothesis 1 (H1) - Private insurance companies increase their volumes of technical
provisions during the period of increased CSLL. aiming the reduction of taxes paid
over profits. This hypothesis was tested by including a dummy variable representing a
temporal division between before and after the increase in the CSLL.
Hypothesis 2 (H2) - Premiums (technical term used to name revenues in insurance
sector) earned by insurance firms did not increase in the same order of technical
provisions. To test this assumption we analyzed the volume of premiums earned and
recorded in income.
Hypothesis 3 (H3) - Selling expenses show no correlation with changes in technical
provisions during the period analyzed. To analyze this assumption we inserted into
the model an item representing the cost of commercial expenses in the firms.
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Hypothesis 4 (H4) - Income taxes expenses (IRPJ and CSLL) are negatively
correlated to changes in technical reserves. This hypothesis was verified with the
insertion of direct tax expenses.
3.
RESEARCH DESIGN
Following the scope of this research, we investigated the practices of earnings
management through a specific accruals model, which according to Martinez (2001)
is defined as the modeling of particularized accounting items, which tend to suffer the
greatest impact on a particular sector, such as technical provisions in insurance
market, enabling the development of a regression model more robust and compatible
with the object of study.
To estimate the model we build a sample-data with quarterly account numbers
published by insurance firms in SUSEP Statistics System. SUSEP, or
Superintendência de Seguros Privados, is the regulatory authority for insurance firms
in Brazil, an agency responsible for control and regulation of this sector in Brazil. The
use of data from quarterly financial statements allows the verification of effects that
could not be detected with the use of annual data (Giroux, 2011). As an example, the
effect of income taxes increase only impacts insurance firms in the second quarter of
2008. Thus, a sample-data was composed of 96 insurance firms with data from the
first quarter of 2007 to the fourth quarter of 2009 (16 quarters), performing a total of
1,536 firm-observations. It is noteworthy that the year 2010 was not included due to
the harmonization process to International Financial Reporting Standards (IFRS),
preventing the creation of biases that could lead to misinterpretation of results.
The econometric model applicable in the analysis is expressed in the follow
equation:
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
𝑃𝑅
𝐶𝐸
= 𝛣0𝑡𝑖 + 𝛣1𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖 + 𝛣2𝑅𝑂𝐴𝑡𝑖 + 𝛣3 𝑇𝐴𝑡𝑖 + 𝛣4 𝑇𝐴𝑡𝑖 +
𝑡𝑖
𝑡𝑖 .
𝑇𝐸𝑡𝑖
𝛣5 𝑇𝐴 + 𝛣6𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑠𝑡𝑖 + 𝑒𝑡𝑖 .
𝑡𝑖 .
Where:
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
𝛣0𝑡𝑖
Sum of changes in technical provisions for insurance over the quarters
divided by total assets.
Slope of the estimated equation.
𝛣1𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖
Dummy variable representing the division between the periods before and
after the increase in CSLL applied to the insurance sector. It assumes value 0
for the quarters of 2006 and 2007 and 1 from the 2nd quarter of 2008 and
2009 (Hypothesis 1).
𝛣2𝑅𝑂𝐴𝑡𝑖
Return of Assets by insurer over the quarters. Control variable included to
mitigate the effect of the disparity between the sizes of companies.
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𝛣3
𝑃𝑅𝑡𝑖
𝑇𝐴𝑡𝑖
Total premium received by the insurance company during the quarter divided
by total assets. Control variable included in the model to mitigate the effect
of increased billing variation in technical provisions (Hypothesis 2).
𝛣4
𝐶𝐸𝑡𝑖
𝑇𝐴𝑡𝑖 .
Total of selling expenses over the quarters divided by total assets. Control
variable used to verify if these expenses would suffer the same variability of
technical provisions in this period (Hypothesis 3).
𝛣5
𝑇𝐸𝑡𝑖
𝑇𝐴𝑡𝑖 .
Total tax expenses by insurance company over the quarters divided by total
assets. Control variable to analyze the amount of tax expenses in this period
(Hypothesis 4).
Quarters studied. A control variable inserted in order to extirpate the natural
effect of time in the series.
𝛣6𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑠𝑡𝑖
𝑒𝑡𝑖
White noise.
We then performed a panel data model. Freitas Vieira and Carneiro (2003)
state that in longitudinal studies of panel data, the same variables are measured in the
same units of analysis for at least two time periods, and is particularly suitable for
investigations changes in individual levels. Diggle et al (2002) point out that this
model allows data evaluation findings about changes in the response variable for an
individual over time and the oscillations between different components of the sample,
increasing the quality of interpretations of causality. The results were obtained
through the statistical software R-Project (version 2.15.2).
4.
EMPIRICAL RESULTS
4.1
Descriptive statistics
A descriptive statistic of the sample variable measures, coupled with the
correlation coefficients between those variables are shown in TABLE 1 and TABLE
2, with the correlations calculated by Spearman method.
It is possible to evaluate by TABLE 1 that the variable “accruals” has a
standard deviation (0.2283), statistically significant when compared to its average
(0.3817). It is reasonable to believe that this dispersion is particularly accentuated by
the presence of firms with different sizes in the sample, then the use of control items
to reduce this effect, such as return on assets (ROA) is important to obtain more
robust estimators.
Still based on the Table 1, it seems that the average technical provisions
weighted by total assets of insurance companies increased after the increase in CSLL.
The p-value obtained shows that this difference is statistically different (and higher) at
a significance level of 1%.
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TABLE 1 – Descriptive statistics
Variable
Increase of
CSLL
Firmsyear
Average
Standarddeviation
-
1.536
0,3817
0,2283
-
1.536
0,0134
0,0488
-
1.536
0,3618
0,4086
-
1.536
0,0494
0,0803
-
1.536
0,1156
0,0124
768
768
0,3660
0,3974
0,2313
0,2444
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
𝑅𝑂𝐴𝑡𝑖
𝑃𝑅𝑡𝑖
𝑇𝐴𝑡𝑖
𝐶𝐸𝑡𝑖
𝑇𝐴𝑡𝑖 .
𝑇𝐸𝑡𝑖
𝑇𝐴𝑡𝑖 .
Before
After
*** - Significant at 1% (0.01)
𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖
Test-t
p-value
1,9631
0,000***
In Table 2 it is possible to analyze the “premium weighted by total assets”
obtained by private insurance companies. It shows a negative (although not
statistically significant) coefficient after the increase of the CSLL (-0.3063), pointing
out that the value decreased after the change. Selling expenses also decreased after
increasing the contribution (-0.0245) but not in statistically significant basis.
Noteworthy is the same effect for variable tax expenses weighted by total assets, that
shows a correlation coefficient of -0.843 (statistically significant at 1%) with the term
INCRCSLL, reinforcing expectations about the use of technical provisions seeking
tax cuts, as predicted in Hypothesis 4. We also highlight the statistical significance of
the correlation coefficients, which mostly were relevant in a confidence interval of
less than 1%, which increases the reliability of research findings.
TABLE 2: Correlation Matrix of Spearman
𝑇𝐸𝑡𝑖
𝐶𝐸𝑡𝑖
Variable
𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖
𝑇𝐴𝑡𝑖 .
𝑇𝐴𝑡𝑖
𝐶𝐸𝑡𝑖
𝑇𝐴𝑡𝑖
𝑇𝐸𝑡𝑖
𝑇𝐴𝑡𝑖 .
𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖
𝑃𝑅𝑡𝑖
𝑇𝐴𝑡𝑖
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
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𝑃𝑅𝑡𝑖
𝑇𝐴𝑡𝑖
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
0,5930
***0,000
-
-0,0245
-0,0843
0,3191
***0,000
0,7646
0,7840
-0,0363
***0,000
***0,000
0,1547
0,2515
0,4430
0,0855
0,2145
***0,000
*0,0826
***0,000
***0,000
-
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𝑅𝑂𝐴𝑡𝑖
ISBN : 9780974211428
0,0065
0,0630
-0,0450
0,0771
-0,1286
0,7978
**0,0134
*0,0776
***0,000
***0,000
* - Significant at 10% (0.10); ** - Significant at 5% (0.05); *** - Significant at 1% (0.01)
4.2
Results of regression model
TABLE 3 shows the results obtained with the regression model of specific
accruals. It is emphasized that the estimators of the model were obtained by
regression to the mean through a longitudinal analysis data (panel model) formed by a
balanced sample-data, considering that the effect of the estimators remain changed
between periods, leading:
TABLE 3: Regression model results
ΣΔ𝑇𝑒𝑐ℎ𝐴𝑐𝑐𝑟𝑢𝑎𝑙𝑠𝑡𝑖
𝑇𝐴𝑡𝑖
𝑃𝑅
𝐶𝐸
= 𝛣0𝑡𝑖 + 𝛣1𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿𝑡𝑖 + 𝛣2𝑅𝑂𝐴𝑡𝑖 + 𝛣3 𝑇𝐴𝑡𝑖 + 𝛣4 𝑇𝐴𝑡𝑖 +
𝑡𝑖
𝑡𝑖 .
𝑇𝐸𝑡𝑖
𝛣5 𝑇𝐴 + 𝛣6𝑄𝑢𝑎𝑟𝑡𝑒𝑟𝑠𝑡𝑖 + 𝑒𝑡𝑖 .
𝑡𝑖 .
Variable
Coefficients
StandardDeviation
t-value
p-value
𝛽0
0,3834
0,0212
18,0896
0,0000
***
𝐼𝑁𝐶𝑅𝐶𝑆𝐿𝐿.
0,0230
0,0053
5,3078
0,0000
***
𝑅𝑂𝐴.
-0,1620
0,0551
-2,9391
0,0033
**
𝑃𝑅/𝑇𝐴
-0,0278
0,0162
-1,7119
0,0871
*
𝐶𝐸/𝑇𝐴
0,5014
0,0756
6,6278
0,000
***
𝑇𝐸/𝐴𝑇
-1,6521
0,4538
-3,6408
0,000
***
2º 𝑄𝑢𝑎𝑟𝑡𝑒𝑟
-0,0065
0,0076
-0,8559
0,3922
3º 𝑄𝑢𝑎𝑟𝑡𝑒𝑟
-0,0041
0,0083
-0,4928
0,6222
4º 𝑄𝑢𝑎𝑟𝑡𝑒𝑟
-0,0258
0,0093
-2,7787
0,0055
N = 1.526 – FD 8
F-statistic
**
R² ajust. =
0,00627
13.9943
< 0.0000 ***
* - Significant at 10% (0.10); ** - Significant at 5% (0.05); *** - Significant at 1% (0.01)
Variable “INCRCSLL” has a positive coefficient and is statistically significant
at 1%, evidencing that the amount of technical provisions increased after the change
in CSLL rate. This effect is consistent with the assumption stated in Hypothesis 1, in
which we assumed that private insurance companies practice earnings management in
search of reduction in income taxes cost.
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Regarding to “ROA”, we verify the significance of this term as a relevant
control variable in the model. This finding confirms the indication performed during
the analysis of descriptive statistics of the sample-data. Due to the presence of
companies with different firm sizes in the database, there was a wide scatter in the
values, captured in the high standard deviations of the variable. Thus, the inclusion of
this variable helped to control this disparity, allowing estimators to be more robust
and reliable. Also regarding to “ROA”, the presence of a negative coefficient on
return on assets (-0.1620), indicates that firms with higher returns tend to have minor
changes in technical provisions. Although this a priori demonstrates that larger
insurers manage their results less, it does not discard the premise that such companies
tend to seek the linearization of their numbers, which characterize the practice of
income smoothing, also considered a form of earnings management.
Analyzing the findings of variable “PR/TA”, the premiums earned by the
companies did not vary in the same way of technical provisions. The reduction (0.0278) in the estimated coefficient points out that changes in technical reserves
increased as the recognition of premiums decreased, showing a negative correlation
between the two variables. This fact allows us to confirm Hypothesis 2, and we can
infer a greater evidence that increases in provisions were aimed solely at the reduction
of income taxes, because the logical consequence would indicate that reserves should
increase, among other factors, by the greater risk exposure that arise from the
acceptance of insurances. So, to the point that they take more risks, they should raise
their premiums. However, the findings of the model show the opposite.
Regarding to the variable “CE/TA”, which was inserted into the model for
testing Hypothesis 3, it has a positive correlation with provisions. According to
TABLE 2, the amount of selling expenses reduced after the increase in CSLL (0.0245). Even though this fact does not allow us to accept Hypothesis 3, it is
interesting to compare the result with the premise established in Hypothesis 2. Once
selling expenses arise only by the implementation of operational activities, they
should have a high positive correlation with the prizes, and in the model they do
(0,7646). However, there is no plausible reason for prizes to show a negative
correlation with technical provisions. If they do, it means they were disproportionally
increased by managers seeking specific objectives in their firms.
In what refers to the direct taxes (“TE/TA”), the estimated coefficient of 1.6521, clearly indicating that increases in technical provisions are directly related to
in the reduction of income taxes. These situation emphasizes the statement that
private insurance companies try to reduce their taxes cost through variations in their
accruals. This result confirms Hypothesis 4.
Finally, it was found that firms increased their volumes of technical provisions
in the fourth quarters of each year. Although this fact allows us to infer that this
would be a more conservative behavior, it is also possible to believe that they use the
last three months of the year in order to increase the volume of expenditure, thus
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decreasing net income and, consecutively, taxable income by the methodology of
annual income taxes. In this method, in which the value of effective taxation of the
profits is only known in December 31 of each year, firms seem to adopt a more
“aggressive” behavior in earnings management than usual in other months along the
year. This result reinforces the findings of Rodrigues (2006) in which the author
shows evidence of the use of technical provisions due to the decrease in taxable
values for income taxes.
5. Conclusions
Throughout the conduct of this study we tried to evaluate whether changes in
tax environmental imposed by governmental jurisdictions with private sector entities
tends to create incentives for firms to practice earnings management. Then, we used
Brazilian insurance companies whose CSLL (a tax based on operating profit)
increased from 9% to 15% in 2008.
The reason for the choice of insurances companies occurred precisely because
of peculiarities of Brazilian taxation law, which allows those firms to use technical
accruals, used by these firms as guarantees against the risk they take in their
operations, as deductible values in tax income. Then, increases in provisioning levels
of technical accruals promote direct effect in decreasing taxation basis.
Results shown in Section 4 show that there was a significant increase in
technical accruals and decrease in tax expenses of insurance companies, showing
robust indications that those firms increased their technical accruals aiming the
reduction of income taxes basis.
We also evaluated variables representing the operating volume of insurances
companies activities, such as premiums and commercial expenses. We included these
items to avoid the natural effect of the increases in business over the periods. We
noted that the premiums decreased during the observed timeliness, but commercial
expenses increased. This is an interesting fact, because the expenses arise from
commercial operations of the business, which is expected to be intrinsically and
positively related to premium variable. This finding demonstrates that technical
accruals moved in a contrary way of premiums, increasing whilst volumes of sales
recognized in income decreased. The result added strength to Hypothesis 1, in which
private insurance companies increase their volumes of technical accruals aiming
reductions in income taxes cost.
These findings indicate that tax environments with greater government
intervention and major changes in laws and rules, especially when such regulations
are applied so uneven to different economic sectors, tend to create greater incentives
for earnings management practices. Changes in regulatory actions directly affect
private organizations, changing the way they interact with the external environment in
which they operate, and we suggest as an indication of interesting future research
issues, assessing whether countries and times with larger changes in taxation rules
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firms tend to perform greater earning management actions, actively changing their
accounting numbers in response to such changes in taxation laws.
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