The impact of firm size on the relation between downward accrual earnings management and tax avoidance

Abstract

This research examines the impact of firm size on the relation between downward accrual earnings management and tax avoidance. Particularly, by hypothesizing that there is a positive impact of downward accrual earnings management on tax avoidance in smaller firms rather than larger firms. This is because small firms can face higher agency problems, higher information asymmetry, and lower political costs. The sample comprises the largest 100 companies listed on the UK Alternative Market (AIM) and UK Main Market from 2010 to 2019, where AIM firms represent smaller firms and Main Market firms represent larger firms. Consistent with the hypothesis, the results suggest that in small firms, the impact of downward earnings management is positively and significantly associated with tax avoidance across two different tax avoidance measures. Additional analyses using 2SLS and PSM also support the same conclusion. Overall, this finding should make an important contribution to various stakeholders, including policymakers and scholars, enabling them to develop more effective strategies for closely monitoring tax avoidance and earnings management practices in small firms equally to the larger ones.