Tax Avoidance and Earning Management in Pakistan

Abstract

Tax avoidance and evasion are major problems in Pakistan. The study attempts to provide information to investors and regulatory authorities of Pakistan about tax avoidance and its consequences. Book Effective Tax Rate (BETR) and Cash Effective Tax Rate (CETR) are used to measure tax avoidance. The unbalanced panel data of 189 non-financial firms are used for empirical analysis. The results of panel regression models show that managers manipulate the profitability signal via tax avoidance. Managers use tax avoidance to beat earnings targets, however, no evidence found to practice tax avoidance to just meet the profitability margin. In line with the behavioral finance view, the quick response of the stock market is positive to tax avoidance because investors focus on profitability without detail screening of cash flows. However, tax avoider firms are likely to have lower future profitability and future stock returns than other benchmark firms.