The Effect of the Capital Gains Tax Rate on Earnings Management

Abstract

I find evidence that when the capital gains tax rates fell before SOX regulations, earnings were managed up by United States based firms through both accrual and real methods. This maximizes executives take home pay. Just following SOX regulations, earnings were managed higher, which was predominately done through accrual methods. When the capital gains tax rates fell in 2013 levels of earnings management were lower, which is consistent with the idea that executives are looking to maximize their pay. How levels of institutional ownership affect earnings management is less conclusive. Earnings management is also influenced by how executives are compensated showing that managers who are primarily compensated through stock options bonuses may choose to manage earnings higher.