1. Marie Curie Research Training Network The IFRS Revolution: Compliance, Consequences and Policy Lessons MRTN-CT-2006-035850 INTACCT Write-offs and profitability in private firms – disentangling the impact of tax-minimisation incentives Urska Kosi University of Macedonia, Lancaster University Aljosa Valentincic University of Ljubljana Varna, Mar 2010

2. MRTN-CT-2006-035850 INTACCT Motivation Burgstahler, Hail and Leuz (2006, p. 988): Studies (e.g. Ball et al., 2000) hypothesize that the link between financial and tax accounting can play an important role in firms’ reporting behavior. … However, there is little direct evidence supporting this hypothesis. Private-firms setting: Role of incentives on financial reporting outcomes Concentrated ownership  agency conflicts, demand for financial reporting Accounting discretion governed by reporting incentives: tax-minimisation, dividend payout, debt financing, employee relations Accounting discretion captured by specific accrual  asset write-offs (increase power of tests) Isolating specific reporting incentive  exogenous change in tax legislation (type of a “natural experiment”) One incentive changed, others remain unchanged Approach substitutes for direct modelling of reporting incentives

3. MRTN-CT-2006-035850 INTACCT Hypothesis Relation between accounting discretion and firms’ reporting incentives  asset write-offs and profitability Accounting standards  negative relation Empirical literature  positive relation (economic benefits) (e.g. Brown et al. 1992, Garrod et al. 2008, Szczesny, Valentincic 2009) Important economic benefit  tax-savings Change in corporate tax legislation  from 2005 current and fixed asset write-offs no longer tax deductible The same reporting incentives but different tax treatment of write-offs  substitutes for direct modelling of firms’ (unobservable) reporting incentives Controlling for known factors in existing literature H: The magnitude of write-offs will decrease if write-offs cease to be a tax-deductible expense, conditional on the decision to write off.

4. MRTN-CT-2006-035850 INTACCT Data & sample Small private firms in Slovenia: 2004 & 2005 20042005 Final sample of small private companies20,505 (100.00%) Companies writing-off assets6,126 (29.88%)5,089 (24.82%) Companies writing-off current assets4,824 (23.53%)3,723 (18.16%) Companies writing-off fixed assets2,262 (11.03%)2,159 (10.53%) Non-writing-off companies14,379 (70.12%)15,416 (75.18%)

5. MRTN-CT-2006-035850 INTACCT Data & sample (cont.) MeanSDQ25MedianQ75Skew Total assets465,0161,635,87842,664129,987406,92325.460 Debt57,805366,2370016,69235.261 Current assets148,564506,10511,57639,301136,15433.320 Fixed assets (incl. intangibles)200,558943,1595,89629,791139,52637.739 Cash21,48578,7671,0525,01617,28036.126 Revenue443,061727,99648,105150,334478,3092.917 Operating profit (pre-write-off)27,613123,5111924,87824,09059.801 Net income19,896135,8922252,83315,24085.029 Tax4,95948,98903462,637150.706 Audited0.0070.0820.000 12.089 Big-4 auditor0.0020.0470.000 21.390

6. MRTN-CT-2006-035850 INTACCT Methodology

7. MRTN-CT-2006-035850 INTACCT Tobit regression

8. MRTN-CT-2006-035850 INTACCT Reverse regression

9. MRTN-CT-2006-035850 INTACCT Sensitivity analyses Test if write-offs signal weakening future performance  insignificant coefficient estimates Including loss dummy variable Modelling decision to write-off (logit models)  incremental decrease in the positive relation

10. MRTN-CT-2006-035850 INTACCT Conclusions Findings confirm that magnitude of write-offs, conditional on the decision to write-off, are positively associated to firm profitability Accounting discretion used to extract economic benefits tax-savings, dividend payouts, employee relations Econometric challenge to disentangle the tax benefit Type of a “natural experiment” (tax legislation change) Approach substitutes for direct modelling of (unobserved) reporting incentives  direct evidence on the tax hypothesis When tax incentives decrease, magnitude of write-offs, conditional on the decision to write-off, decreases

11. MRTN-CT-2006-035850 INTACCT Thank you for questions, comments, suggestions!