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The Degradation of Reported Corporate Profits

The Journal of economic perspectives, 2005-10, Vol.19 (4), p.171-192 [Peer Reviewed Journal]

Copyright 2005 American Economic Association ;Copyright American Economic Association Fall 2005 ;ISSN: 0895-3309 ;EISSN: 1944-7965 ;DOI: 10.1257/089533005775196705

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  • Title:
    The Degradation of Reported Corporate Profits
  • Author: Desai, Mihir A.
  • Subjects: Accounting ; Business structures ; Capital market ; Capital markets ; Corporate income taxes ; Corporate profits ; Corporate taxes ; Earnings ; Enterprises ; Financial management ; Financial reporting ; Financial statements ; Income taxes ; Investments ; Net income ; Profit ; Profit forecasting ; Profitability ; Profits ; Reconciliation ; Scandals ; Studies ; Tax avoidance ; Tax increases ; Tax returns ; U.S.A
  • Is Part Of: The Journal of economic perspectives, 2005-10, Vol.19 (4), p.171-192
  • Description: Recent corporate scandals have highlighted abuses by firms overstating profits to capital markets. In a related but less noticed vein, the reporting of profits to tax authorities has come under increased scrutiny with heightened concerns over the spread of tax avoidance activities. How could firms simultaneously be inflating profits reported to the capital markets and understating profits reported to tax authorities? The practical answer is that American firms keep two sets of financial statements: a financial statement that reports “book profits” to the capital markets and a separate financial statement that reports “tax profits” to the government. These two profit reports can bear little resemblance to each other and follow distinct rules. This paper argues that the latitude afforded managers by the dual nature of corporate profit reporting has contributed to the simultaneous degradation of profit reporting to capital markets and tax authorities. The distinction between book and tax profits allows managers the ability to mischaracterize tax savings to capital markets and to mischaracterize profits to tax authorities. Examination of three high-profile cases of managerial misreporting of profits and tax avoidance—at Enron, Tyco and Xerox—reveals how the drive to improve reported book profits fosters tax avoidance and how the drive to limit taxes gives rise to the manipulation of accounting profits and managerial malfeasance.
  • Publisher: Nashville: American Economic Association
  • Language: English
  • Identifier: ISSN: 0895-3309
    EISSN: 1944-7965
    DOI: 10.1257/089533005775196705
  • Source: ProQuest Central
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