Tax Break

Paying more in taxes to burnish EPS

November 19, 2012

Just how important is it for public companies to post earnings that meet investors’ expectations? Important enough to knowingly pay more in taxes, according to a recent study by academics at Duke, MIT and UC Irvine, ”Incentives for Tax Planning and Avoidance: Evidence from the Field.”

 It’s hard to get surprised about the idea that meeting or beting their earnings numbers is important to companies, but Duke Professor John Graham, an author of the paper, was surprised that the 600 corporate tax executives they interviewed overwhelmingly said they’d trade real hard cash paid to the government in taxes in exchange for a boost to the earnings number reported to shareholders.

Earnings per share, a number calculated according to the Generally Accepted Accounting Principles, is a “non-cash” number.

In the study, 84 percent of the accounting officers at public companies said top management cares as much or more about reported earnings as they do about cash taxes.  Private company executives cared far less about EPS than their public company peers.

Even tax planning is often about EPS: 57 percent of the public company chief accountants said that increasing EPS is “an important outcome from a tax planning strategy.”

The most famous example of a company trading taxes for better earnings, said Graham, is AOL. Long ago, when someone signed up for AOL they did so after installing information from a floppy disk. Shipping that was a marketing expense, and recognizing it right away would have lowered AOL’s tax bill. Instead, the company capitalized the expense over a number of years. That lowered expenses, and boosted earnings, a practice the company eventually had to undo after settling a Securities and Exchange Commission  investigation.

Why would an accountant of all people be willing to give up cash earnings just to make a GAAP number look better?

Good question, said Graham:  “In the long run it just doesn’t make sense. You are hurting your company in the long run just because the master is the stock market.”

 

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