Credit Ratings, Tax Considerations, and Accrual Management by Private UK Firms

• In Event: Forum on Corporate Reporting

Abstract

We investigate how credit market pressures and tax considerations affect financial reporting strategies of private UK firms. We find private firms close to a credit rating category boundary manage accounting accruals upward (categories being high risk, cautious, normal, stable, secure). We also find that among private companies there is a pecking-order for which type of accruals these firms manage first. Private firms are sensitive to whether the accrual management triggers taxation or not and, we therefore, split our measure of accrual management into two parts, tax-affecting and non-tax-affecting accruals. We find that private firms prefer to revalue fixed assets, an event which is not reported in the income statement, and only if this revaluation does not move them to the desired credit category, do these firms top up their accrual management by using tax-affecting working capital accruals the following year. We also find that these activities have a positive effect on the credit rating. Overall, our results suggest that there are considerable differences between how credit ratings affect accounting choices related to accruals management among publicly traded and private firms, and further, that large scale credit rating methods do not detect this behaviour.

Authors

• Mari Paananen, University of Gothenburg

• Joanne Horton, University of warwick

• Fani Kalogirou, University of Exeter