The Financial Reporting Consequences of Last Chance Earnings Management

Given its opacity and the timing of its closure, the tax expense represents a theoretically and intuitively plausible mechanism for managers to manipulate earnings in order to achieve performance benchmarks (i.e., last chance earnings management or LCEM). Although empirical analyses of effective tax rates are consistent with this behavior, its consequences are unclear. We investigate whether LCEM is associated with lower financial reporting quality. Contrary to our expectations, we fail to find evidence that LCEM is associated with tax-related restatements or comment letters, with scaled confidence intervals reliably near zero. In cross-sectional tests, we fail to find this association in subsamples where LCEM is more likely to represent impaired financial reporting quality. Additionally, we fail to find that LCEM is associated with reduced tax accrual quality. Collectively, our results caution interpreting reductions in effective tax rates to achieve performance benchmarks as indicative of impaired financial reporting quality.