




































BANGLADESH JOURNAL OF MULTIDISCIPLINARY SCIENTIFIC RESEARCH 9(2) (2024), 30-44 

30 

        MULTIDISCIPLINARY SCIENTIFIC RESEARCH 
          BJMSR VOL 9 NO 2 (2024) P-ISSN 2687-850X E-ISSN 2687-8518 

         Available online at https://www.cribfb.com 

     Journal homepage: https://www.cribfb.com/journal/index.php/BJMSR 

                                                                                                                                                                                                    Published by CRIBFB, USA 
                                                                                                                                     

TAX AVOIDANCE AND EARNINGS MANAGEMENT IN 

MALAYSIAN FIRMS: IMPACT OF TAX INCENTIVES    
 

 Salsiah Mohd Ali (a)1        Mariati Norhashim (b)   Nahariah Jaffar (c) 
 

(a) Lecturer, Faculty of Sciences, Faculty of Accountancy, Universiti Teknologi MARA, Cawangan Selangor, Kampus Puncak Alam, 

42300, Puncak Alam, Selangor, Malaysia; E-mail: salsiahma@uitm.edu.my 
(b) Senior Lecturer, Faculty of Management, Multimedia University, Persiaran Multimedia, 63100 Cyberjaya, Malaysia; E-mail: 

mariati.norhashim@mmu.edu.my  
(c) Associate Professor, Putra Business School, Level 3, Office Building of the Deputy Vice Chancellor (Research & Innovation), UPM, 

Serdang, Selangor, Malaysia; E-mail: nahariah@putrabs.edu.my               
       

 
A R T I C L E I N F O 

 
 

Article History: 
 

Received: 10th May 2024 

Reviewed & Revised: 11th May 

to 20th July 2024 

Accepted: 24th July 2024 

Published: 27th July 2024 

 
Keywords: 

 

Tax Avoidance, Tax Incentive,  

Earnings Management, Effective  

Tax Rate, Discretionary Accruals  

Earnings Management 

 
JEL Classification Codes: 

 

H26, M4, M48 
 

      Peer-Review Model:  

 

      External peer review was done through  

      double-blind method        

 
A B S T R A C T 

 
Understanding the relationship between tax avoidance and earnings management is crucial to 
evaluating tax policies and ensuring transparent financial reporting. Prior research has highlighted 

complexities and inconsistent findings, particularly concerning the impact of tax-related reporting 

incentives. This study addresses these issues by examining the influence of tax incentive recipient status 

on tax avoidance and earnings management among firms listed on the Kuala Lumpur Stock Exchange 

(KLSE). It examines whether firms receiving tax incentives from the Malaysian Investment Development 

Authority (MIDA) exhibit different earnings management behaviours than non-recipient firms. This 

study employs the effective tax rate (ETR) as a measure of tax avoidance and discretionary accruals 
(DEM) for earnings management. The dataset includes manually extracted financial information from 

firms listed on the KLSE for the financial year 2017 and a listing of tax incentive recipient firms from 

MIDA. Analytical techniques include ANOVA, independent samples t-test, and multiple regression 

analysis. The findings of this study suggest that higher tax avoidance relates to higher earnings 

management. Additionally, firms receiving tax incentives exhibit significantly higher ETRs than non-

recipients. They are less likely to engage in earnings management, suggesting that tax incentives may 

deter aggressive financial reporting practices due to compliance pressures. The additional analysis 

indicates that tax incentives do not significantly moderate the relationship between tax avoidance and 
earnings management, implying that other pressures still play a crucial role. This study contributes to 

existing knowledge by emphasizing the need for robust regulatory frameworks that balance economic 

growth and financial reporting integrity. 

 
 

© 2024 by the authors.   Licensee CRIBFB, USA. This open-access article is distributed under the 
terms and conditions of the Creative Commons Attribution (CC BY) license 
(http://creativecommons.org/licenses/by/4.0).  

            

 

INTRODUCTION 

Understanding the effects of tax avoidance strategies on corporate governance and financial reporting integrity is 

challenging due to the complexity of tax regulations and their widespread use. This complexity is further heightened by 

various factors, as reported by prior studies. For example, challenges in economic recovery post-COVID-19 (Karlinah et 

al., 2024), the influence of powerful CEOs and diverse boards on reducing tax burdens (Hooy & Phua, 2023), and 

international regulatory cooperation (Yu et al., 2024) all contribute to the complexity in understanding the effect of tax 

avoidance practices. Additionally, high non-tax costs, such as audit risks and operational frictions (McClure, 2023), along 

with the unique firm characteristics, agency costs, and objectives of tax avoidance strategies, such as lowering the debt costs 

(Sánchez-Ballesta & Yagüe, 2021), further complicate the landscape. On the other hand, Balakrishnan et al. (2019) 

emphasize that a lack of tax transparency also complicates this situation, making it difficult to evaluate how decreases in 

tax burdens due to tax avoidance affect reporting incentives. The potential for financial data manipulation related to 

avoidance strategies affects regulatory scrutiny and interferes with investor decision-making. 

High-profile events like the Luxembourg leaks in 2014, the Panama Papers in 2016, and the Paradise Papers in 

2017 have brought attention to the prevalent practice of corporate tax avoidance (Fitzgibbon & Starkman, 2017). These 

disclosures underscore significant declines in government revenues on a global scale. For instance, corporate tax avoidance 

in the United States reduces tax revenues by around $70 billion annually, accounting for approximately 20% of total 

corporate tax receipts (Zucman, 2017). In underdeveloped countries, such as those in West Africa, the amount of tax income 

lost each year due to avoidance is substantial. Nigeria alone contributes $2.9 billion to the total loss of $9.6 billion (Shaxson, 

                                                      
1Corresponding author: ORCID ID: 0000-0003-0523-6293 

© 2024 by the authors. Hosting by CRIBFB. Peer review is the responsibility of CRIBFB, USA.  

https://doi.org/10.46281/bjmsr.v9i2.2223 
 

To cite this article: Ali, S. M., Norhashim, M., & Jaffar, N. (2024). TAX AVOIDANCE AND EARNINGS MANAGEMENT IN MALAYSIAN FIRMS: 

IMPACT OF TAX INCENTIVES. Bangladesh Journal of Multidisciplinary Scientific Research, 9(2), 30-44. https://doi.org/10.46281/bjmsr.v9i2.2223 

http://creativecommons.org/licenses/by/4.0/)
http://creativecommons.org/licenses/by/4.0/)
https://www.openaccess.nl/en
https://doi.org/10.46281/bjmsr.v9i2.2223
https://orcid.org/0000-0003-0523-6293
https://orcid.org/0000-0002-2812-6807
https://orcid.org/0000-0002-2072-0879


Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

31 

2015). Recent data from Malaysia reveal that tax avoidance resulted in a significant loss of RM6.34 billion in 2023, 

exceeding the annual budgets of critical ministries, including Health and Education, as Pfordten (2024) reported in The Star 

newspaper. These findings highlight the urgency of promptly addressing these difficulties. 

Therefore, understanding the relationship between tax avoidance and earnings management has become a central 

study area for addressing these significant issues. This focus is motivated by the substantial impact on the quality of financial 

reporting and company conduct, which can affect users' decision-making. The considerable revenue losses due to tax 

avoidance recorded by the Inland Revenue Board in Malaysia underline the importance of this research. It is vital to 

understand the reasons that lead corporations in Malaysia to minimize tax liabilities and potentially engage in manipulative 

accounting methods and whether financial reporting can become a credible platform for both regulatory bodies and other 

users to anticipate such tax-related reporting incentives in firms' reporting in response to any tax policy change. These 

activities challenge the interests of shareholders and affect the integrity of financial statements. We can improve regulatory 

scrutiny and investor decision-making by addressing these issues.  
Thus, this study aims to understand better the complex relationship between tax avoidance, earnings management, 

and tax incentives among publicly traded companies in Malaysia. More precisely, it seeks to investigate how tax incentives 

influence the actions of companies involved in tax avoidance strategies. This research seeks insights into optimizing tax 

policies to promote compliance and improve transparency in financial reporting by comparing the economic practices of 

organizations that receive tax incentives with those that do not. By doing so, the study aims to provide a comprehensive 

understanding of how tax policies can be structured to reduce tax avoidance and enhance the overall quality of financial 

reporting. 

 The remaining paper structure includes Section two, which reviews the literature on the relationship between tax 

avoidance and earnings management.   Section three details the study's methodology, including the sample selection and 

data analysis techniques. Results and discussions are presented in Section four, and the study's conclusions are provided in 

Section five. 

 

LITERATURE REVIEW 

Effective Tax Rate and Discretionary Accruals Earnings Management 
Investigating the relationship between tax avoidance, measured by Effective Tax Rate (ETR), and discretionary accruals 

earnings management (DEM) is crucial due to its complexity and the diverse findings in the literature (Akter, 2021; Blaylock 

et al., 2015; Desai & Dharmapala, 2006; Karjalainen et al., 2023; Seidman & Stomberg, 2017). Prior studies produce 

inconsistent results, partly (among other factors) due to various methodological limitations and the broad spectrum of tax 

avoidance activities that ETR alone cannot capture (Gupta & Newberry, 1997; Hanlon & Heitzman, 2010; Mills & 

Newberry, 2001). Research shows mixed findings regarding the relationship between ETR and earnings management.   

Guenther et al. (2021) provide a theoretical framework to identify when tax avoidance measures reflect tax avoidance related 

to and unrelated to earnings management. They highlight that alternative measures like the ratio of cash taxes paid to pretax 

operating cash flows can avoid attributing earnings management results to tax avoidance. In addition, while ETR serves as 

a standard proxy for tax avoidance, it fails to encompass the full spectrum of tax avoidance strategies (Gupta & Newberry, 

1997; Hanlon & Heitzman, 2010; Mills & Newberry, 2001) Studies indicate that ETR primarily reflects the reduction of 

explicit taxes but does not capture if the practice is due to aggressive tax planning and tax sheltering activities (Blaylock et 

al., 2015; Hanlon & Heitzman, 2010).   Methodological constraints limit ETR's ability to account for temporary differences 

and other tax timing strategies (Blaylock et al., 2015). Empirical findings, such as those by Karjalainen et al. (2023) and  

Seidman and Stomberg (2017), illustrate the varied results and challenges in measuring tax avoidance solely through ETR, 

suggesting it might underreport aggressive tax strategies, especially in multinational corporations with sophisticated tax 

planning capabilities (Ardyansah & Zulaikha, 2014). 

Hanlon and Heitzman (2010) define tax avoidance as the deliberate reduction of explicit taxes but also acknowledge 

the challenges in capturing aggressive tax planning and tax sheltering through ETR alone. Dyreng et al. (2008) expand on 

this by including aggressive tax avoidance, tax sheltering, and tax risk in their definition, which may need to be adequately 

reflected in a simple ETR measure. This limitation is significant because it suggests that ETR, as a measure, might need to 

capture the complexities of corporate tax avoidance behaviours fully. Frank et al. (2009) explore how higher effective tax 

rates incentivize firms to manage earnings to align reported earnings with tax liabilities. They find that firms with volatile 

earnings are particularly prone to such manipulations as a means to present a stable financial outlook. This aligns with the 

findings of Desai and Dharmapala (2006), who note that complexities and ambiguities in tax codes provide fertile ground 

for earnings manipulation, especially for firms with sophisticated tax planning capabilities. Gupta and Newberry (1997) 

provide an international perspective, showing that firms in countries with stringent tax regulations and higher tax rates are 

more inclined to manage earnings to minimize taxable income. Their comparative analysis highlights the significant role 

that external tax environments play in shaping corporate financial behaviours. However, Guenther et al. (2017) find low tax 

rates usually stay low over time, with no substantial evidence that these tax-avoiding actions lead to more giant swings in 

future tax payments or stock prices. In other words, tax strategies, including tax incentives, can lower the amount of tax a 

company has to pay and make their financial reporting more transparent; they might not significantly affect the overall 

riskiness of the company's tax avoidance strategies. 

Further, more recent studies also demonstrate the complex relationship between ETR and earnings management.   

For example, Delgado et al. (2023) find that discretionary accruals have a positive and statistically significant relationship 

with ETR indicators, suggesting that earnings management, measured by discretionary accruals, does not necessarily 

correlate with aggressive tax avoidance. Adding to the complexity, the geographical variability in research findings makes 

it difficult to draw definitive conclusions. 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

32 

In the U.S., studies by Dhaliwal et al. (2004) and Blaylock et al. (2015) identify a strong link between aggressive 

tax strategies and aggressive financial reporting. However, Guenther et al. (2017) report a negative relationship, suggesting 

that different proxies for tax avoidance and earnings management can lead to divergent conclusions. Shim et al. (2022) 

examine the effects of earnings management on effective tax rates (ETR) and recommend using an alternative measure of 

operating cash flow-based effective tax rate (CFO ETR) to account for the robustness against earnings management. Their 

findings suggest that ETR might overestimate tax avoidance due to earnings management, emphasizing the need for a dual 

approach in empirical analysis. These conflicting results indicate that regional factors, such as regulatory environments, 

corporate governance practices, and cultural differences, also play a significant role in shaping these relationships, among 

other factors.  

The above discussion shows that understanding these complexities and inconsistencies is essential for developing 

more effective tax policies and improving financial reporting quality. This study addresses these gaps by examining the 

relationship between DEM and tax avoidance in Malaysian listed companies. The unique regulatory environment and 

specific tax incentives in Malaysia provide a relevant and vital setting for such an investigation. 

 

Firm’s Tax Incentive Recipient Status (MIDA) and the Magnitude of Discretionary Accruals (Earnings 

Management) 
Tax incentives are a standard policy tool to promote economic growth, attract investment, and encourage innovation.   

However, it is argued that the receipt of the tax incentive can have mixed outcomes and sometimes lead to unintended 

consequences, especially in financial reporting and earnings management. The complexity arises because tax incentives can 

create pressure to comply with regulatory expectations while simultaneously aiming to minimize tax burdens.   Given these 

dynamics, it is essential to design tax incentive policies thoughtfully. Prior studies offer varied insights, indicating a need 

for further investigation into how tax incentives impact corporate behaviour. Most studies on tax incentives focus on their 

impact on investment and job creation, but they often overlook their effects on financial reporting practices. Okoth (2023), 

for example, investigates tax incentives in emerging economies like Indonesia, Kenya, Malaysia, and Türkiye, finding that 

tax incentives for production, sales, transfers, profits, and capital gains may slightly boost investment but often have a non-

significant or even negative effect on overall economic growth. This suggests that tax incentives might not consistently 

deliver the expected economic outcomes. 

In contrast, Kang et al. (2023) reveal that fiscal subsidies and tax incentives can promote corporate innovation, but 

their effectiveness depends on broader economic conditions. Fiscal subsidies have a more significant impact during 

economic downturns, while tax incentives are more effective during periods of growth. This observation implies that the 

context in which tax incentives are applied plays a critical role in determining their success.   

Additionally, Ghazinoory and Hashemi (2021) explore tax incentives and direct financial support, showing that 

both can encourage corporate growth, but their effectiveness varies, particularly in high-tech industries. Direct support for 

R & D investment is more effective for large companies, while tax incentives are more successful in promoting new product 

development. This finding underscores the need to tailor tax policies to specific industry needs and company sizes. On the 

other hand, Klemm and Van Parys (2012) examine tax incentives in over 40 countries and find that reduced corporate 

income tax (CIT) rates and extended tax holidays attract foreign direct investment (FDI) in some regions but not in others.   

This suggests that tax incentives can stimulate economic growth in specific contexts but do not explore their impact on 

financial reporting. This gap raises concerns about whether tax incentives encourage earnings management or financial 

misreporting to meet regulatory benchmarks. Adding to the complexity, Caiumi (2011) finds that regional investment tax 

credits in Italy's Piedmont region positively impact productivity and investment at the firm level. However, other studies, 

such as those by Kolko and Neumark (2010) and Bondonio and Greenbaum (2006), report mixed results, indicating that tax 

incentives only sometimes lead to consistent job growth or economic stability. 

Moreover, the mixed results from studies on tax incentives raise concerns about their potential to pressure firms to 

engage in manipulative financial practices to meet regulatory expectations. This pressure could lead firms to adjust their 

financial reporting to satisfy specific regulatory benchmarks or avoid scrutiny. Given these risks, careful implementation 

and oversight of tax incentives are crucial to ensure they do not unintentionally encourage harmful financial behaviour.   

However, only some studies have examined this issue in depth, leaving significant gaps in our understanding. For example, 

Capras et al. (2024) examine whether tax avoidance is a purpose of financial data manipulation in Romanian companies.   

Their study indicates a negative association between effective tax rates and earnings management, suggesting companies 

manipulate earnings to reduce tax burdens. They also find that return on assets (ROA) negatively influences the effective 

tax rate, while firm size, growth, and Big4 audit have no significant effect. 

Similarly, Tian et al. (2020) investigate China's super deduction policy, which allows firms with less than a 10% 

increase in prior-year R&D expenditures to claim a 50% tax deduction. Their findings indicate that firms newly eligible for 

these tax incentives catch up in R&D spending and product innovation without showing signs of financial manipulation or 

misreporting. Taxes are designed and implemented carefully, and tax incentives can promote positive corporate behaviour 

without triggering earnings management. 

However, contrasting evidence comes from Wang et al. (2024), who study China's 2014 accelerated depreciation 

policy for fixed assets. This policy increases earnings management, implying that tax incentives sometimes encourage firms 

to manipulate financial statements. This might occur when firms feel pressured to meet regulatory expectations or seek ways 

to minimize their tax burden without resorting to aggressive tax avoidance. In addition, Wu (2024) investigates the 

interaction between incentive and opportunity in corporate tax planning, focusing on financially constrained firms. Wu's 

study reveals that financial constraints, as an incentive factor, strengthen the positive association between tax planning 

opportunities (TPOs) and tax avoidance. This highlights that firms with higher TPOs are more likely to engage in tax 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

33 

avoidance when under financial constraints. Wu's findings underscore the importance of considering incentive and 

opportunity factors in understanding corporate tax planning behaviour. 

These contradictory findings underline the complexity of tax incentives and their potential impact on financial 

integrity. The dual nature of tax incentives—as both a compliance tool and a tax relief mechanism—creates a challenging 

environment for policymakers. On the one hand, tax incentives can encourage positive corporate behaviour by promoting 

investment and innovation. On the other hand, they can inadvertently foster an environment where firms feel compelled to 

manipulate financial information to meet regulatory expectations. The uncertainty surrounding these outcomes emphasizes 

the need for additional research to understand the broader implications of tax incentives on corporate behaviour, especially 

regarding financial reporting and earnings management. Policymakers must know the risks and carefully design tax 

incentive programs that promote economic growth without compromising financial integrity. This balance is crucial for 

maintaining a healthy business environment and ensuring that tax policies do not create unintended incentives for financial 

misreporting. These varied outcomes suggest that tax incentives can have different effects depending on the context, 

industry, and specific design of the incentives. The dual nature of tax incentives—as both a regulatory benchmark and a tax 

relief mechanism—creates a complex environment where these incentives could either encourage or discourage earnings 

management. This ambiguity highlights the need for further research to guide the design of tax policies that promote 

economic growth while safeguarding financial integrity. Given the limitations in prior studies, this study aims to explore 

the relationship between tax avoidance, tax incentives, and earnings management, addressing both regulatory pressures and 

the opportunities for reducing tax burdens without resorting to aggressive avoidance strategies. This research seeks to clarify 

the role of tax incentives in corporate financial behaviour and provide policymakers with insights for creating compelling 

and balanced tax policies. In addition to the conflicting results, it is also unclear whether tax incentives generally lead to 

increased or decreased earnings management. The complexity of their dual role—acting as both a regulatory benchmark 

and a tax relief mechanism—implies that these incentives could encourage or discourage earnings management. This 

uncertainty reinforces the need for further research to understand these relationships and guide the design of tax policies 

that balance economic growth with financial reporting integrity. 

Effective Tax Rates between Malaysian Public Firms with MIDA Status and Those without MIDA Status 
Tax incentives in Malaysia, particularly those overseen by the Malaysian Investment Development Authority (MIDA), have 

shaped corporate tax behaviours. These incentives, designed to foster economic growth, include Pioneer Status, Investment 

Tax Allowance, and Reinvestment Allowance, among others. The effectiveness of these incentives in reducing tax burdens 

and promoting transparency in financial reporting has been a subject of significant debate. 

Malaysia features a prevalent range of tax incentives, encompassing income exemptions, capital expenditure 

allowances, double deductions for expenses, preferential tax treatments for promoted sectors, and exemptions from import 

and excise duties. Although Malaysia does not fall under the classification of a tax haven or a low-tax jurisdiction, certain 

eligible firms can benefit from considerably reduced effective tax rates compared to the ordinary corporate tax rate of 24%.   

As an illustration, a manufacturing firm eligible for a pioneer status tax incentive experiences an effective tax rate of 7.2%.   

Furthermore, only 30% of its profits are liable to be taxed. Integrating tax incentives to mitigate growth risks or pursue 

economic and social objectives is a widespread fiscal mechanism, particularly in developing nations. These incentives, such 

as tax credits, aim to stimulate economic activities that might not occur or would occur to a lesser extent without such 

credits. This approach is widely embraced as an economic development tool in countries like Malaysia. 

Facilitating these efforts, the Malaysian Investment Development Authority (MIDA) assumes a fundamental role, 

overseeing the promotion and facilitation of both foreign and domestic investments in Malaysia, including the administration 

of tax incentives. Collaborating with entities like the Ministry of Finance and the Inland Revenue Board, MIDA ensures an 

environment conducive to investment. Various tax incentives, such as Pioneer Status, Investment Tax Allowance, and 

Reinvestment Allowance, are offered to eligible companies and designed to foster investments in vital economic sectors.   

For instance, Pioneer Status grants a 70% tax exemption on the company's statutory income over five years, while 

Investment Tax Allowance allows a deduction of 60% for qualifying capital expenditure within five years from the first 

qualifying capital expenditure. Reinvestment Allowance offers a 60% deduction for qualifying capital expenditure within 

twelve years from the initial expenditure. In addition to these incentives, MIDA supports investors in obtaining necessary 

approvals and licenses, such as manufacturing licenses and expatriate posts, facilitating investments. This incentive-driven 

approach has proven successful in promoting investments in targeted sectors of the Malaysian economy. 

Research indicates that tax incentives can impact firms' effective tax rates (ETRs) and financial reporting practices.   

For example, Bornemann et al. (2023) analyze the impact of intellectual property (IP) boxes on innovative activity and tax 

benefits. Their study shows that adopting IP boxes increases innovative activity, such as patent applications and grants, 

while also lowering effective tax rates for firms with patents. The findings suggest that IP boxes can lead to modest increases 

in innovative activity and significant tax benefits, particularly for multinational firms. Further, Zhang et al. (2023) explore 

the effect of local fiscal pressure on corporate tax avoidance behaviour using the abolition of agricultural tax reform as a 

quasi-natural experiment. They find that sudden loss of fiscal revenue reduces tax evasion by encouraging firms to improve 

productivity. Thus, firms with MIDA status often benefit from substantial tax reductions, potentially encouraging and 

discouraging the need for more aggressive tax avoidance. Several factors, including regulatory oversight, corporate 

governance, and the firms' strategic objectives, influence the relationship between tax incentives and ETRs. Noor et al. 

(2008) highlight that Malaysian tax reforms aim to attract foreign investment and stimulate economic growth by offering 

various tax incentives. These incentives are intended to reduce the effective tax burden on companies, thereby enhancing 

their financial performance and competitive edge. However, Derashid and Zhang (2003) argue that while these incentives 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

34 

can stimulate investment, they might also encourage firms to engage in aggressive tax planning to maximize their tax 

benefits, potentially leading to less transparent financial reporting. 

Moreover, Chien et al. (2021) find that tax incentives in Malaysia, such as the Pioneer Status and Investment Tax 

Allowance, are associated with lower ETRs for recipient firms. This reduction in tax liability provides these firms with 

additional resources to reinvest in their operations, theoretically promoting growth and innovation. However, the study also 

notes that the effectiveness of these incentives depends significantly on the firms' adherence to compliance requirements 

and the rigour of regulatory enforcement. Ghazinoory and Hashemi (2021) explore the impact of tax incentives on corporate 

growth, noting that while these incentives can promote investment and economic development, they also create opportunities 

for earnings management. Firms may manipulate their financial statements to appear compliant with tax incentive 

requirements, thereby securing tax benefits while potentially obscuring their financial position. This dual effect underscores 

the complexity of tax incentives as both a tool for economic stimulation and a potential catalyst for financial manipulation. 

Studies on the relationship between tax incentives, effective tax rates, and earnings management present a complex 

picture. While tax incentives can reduce tax burdens and promote investment, they also have the potential to either encourage 

or discourage earnings management and financial manipulation. This notion has yet to be fully understood in the existing 

literature.   In the context of Malaysian public firms, the impact of MIDA status on effective tax rates (ETRs) and earnings 

management is particularly significant. While tax incentives can provide substantial financial benefits to recipient firms, 

ensuring these incentives do not lead to manipulative financial practices is crucial. This requires robust regulatory 

frameworks and effective corporate governance mechanisms to monitor and control managerial behaviour, thereby 

enhancing the transparency and reliability of financial reporting. 

Thus, this study aims to examine the impact of the status of tax incentives received on earnings management and 

effective tax rates in Malaysian public firms. Specifically, it investigates the relationship between tax incentive status 

(MIDA), effective tax rates, and the magnitude of discretionary accruals. Building on insights from the literature, the 

following hypotheses are formulated: 

 

H1: There is a significant and negative relationship between effective tax rate and discretionary accruals earnings 

management. 

H2: There is a significant relationship between a firm’s tax incentive recipient status (MIDA) and the magnitude of 

discretionary accruals (earnings management). 

H3: There is a significant difference in the effective tax rates between Malaysian public firms with MIDA status and those 

without MIDA status. 

 

MATERIALS AND METHODS 

Research Design 

This study investigates the relationship between tax avoidance and earnings management among Malaysian public firms 

listed on the Kuala Lumpur Stock Exchange (KLSE) for the financial year 2017. The stable financial reporting environment 

justifies the choice of 2017 before significant accounting changes (MFRS 15 and MFRS 16), political shifts in 2018, and 

the disruptions caused by the COVID-19 pandemic starting in 2020. By focusing on 2017, the study avoids these 

confounding factors, allowing for a more precise analysis of corporate behaviour and financial reporting practices. 

 

Sample Selection 

The study initially targeted all Malaysian public firms listed on the KLSE as of December 2017. From these, 390 firms 

across 11 sectors were randomly selected based on their core business activities, and utilities and financial firms were 

excluded due to their unique tax planning opportunities and incentives. Further exclusions were made for firms with net 

operating losses or negative cash flow (Gupta & Newberry, 1997; Kim & Limpaphayom, 1998), negative pretax income 

(Rohaya et al., 2010), effective tax rates (ETRs) exceeding one (Gupta & Newberry, 1997; Kim & Limpaphayom, 1998), 

and negative ETRs (Zimmerman, 1983). The final sample consisted of 202 firms. Table 1 presents the sample selection 

details, resulting in a final sample of 202 firms. 

 

Table 1.   Summary of the sample selection details 

 
Sample Selection Number of Firms 

Listed firms in KLSE original sample  390 

Exclude: Firms with net operating loss (or negative cash flow) and net operating loss carryforward 68 

Exclude: Firms with negative pretax income 58 

Exclude: Firms with an effective tax rate (ETR) exceeding one 47 

Exclude: 2%–5% outlier procedure 15 

Final sample 202 

Firms in the list of top 500 MIDA tax incentive recipients (TR firms) 48 

Firms not on the list of top 500 MIDA tax incentive recipients 154 

 

To ensure the adequacy of the sample size, a power analysis was conducted using GPower software, considering 

an effect size of 0.15, an alpha level of 0.05, and a desired power of 0.95. The GPower analysis indicated a total sample size 

of 194 participants would be appropriate. Recognizing the importance of sample size in research design, this study opted to 

surpass the recommended minimum, recruiting 202 participants to ensure adequate statistical power and reduce the 

probability of Type II errors. 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

35 

 
 

Figure 1. G Power Intepretation 

 

Data Analysis Tools and Software Used 

The research question and objectives were analyzed through quantitative data analysis using SPSS software to perform 

multiple regression analysis and t-tests, as well as various validity tests to guarantee the accuracy and reliability of the data 

(Field, 2013). SPSS was chosen for its ability to handle complex data structures and multiple variables, making it ideal for 

running multiple regression analyses, thus increasing the accuracy and reliability of the findings (Salkind, 2017). SPSS 

provided various tools for testing the validity and reliability of the data. Normality tests were conducted to check if the data 

followed a normal distribution, and multicollinearity tests were conducted to ascertain the absence of significant correlations 

among the independent variables. These tests helped to ensure that the results were accurate and reliable and that the 

statistical assumptions underlying the analysis were met (Tabachnick et al., 2013). In conclusion, SPSS was justified in this 

study as it provided a powerful statistical analysis tool for examining the relationships between variables and allowed for 

various validity and reliability tests to be conducted. The results obtained from this analysis were statistically significant, 

contributing to a greater understanding of the research question and objectives (Pallant, 2020). 

 

Measures of Earnings Management 

This study focuses on discretionary accruals, identified using the modified Jones model, a widely applied and reliable 

method for detecting earnings management (Dechow et al., 1995; Xie, 2001).  

 

𝐷𝐸𝑀{𝜏} =  𝑇𝐴{𝜏} −  𝑁𝐷𝐴{𝜏}-----------------------------------------------------------------------------------------(1) 

 

𝑇𝐴{𝜏} =  𝑎1( {1}/{𝐴{𝜏−1}}) + 𝑎2(𝛥𝑅𝐸𝑉{𝜏}) + 𝑎3(𝑃𝑃𝐸{𝜏}) +  𝜈{𝜏}-------------------------------------------(2) 

 

𝑁𝐷𝐴{𝜏} =  𝛼1( {1}/{𝐴{𝜏−1}}) +  𝛼2(𝛥𝑅𝐸𝑉{𝜏} −  𝛥𝑅𝐸𝐶{𝜏}) +  𝛼3(𝑃𝑃𝐸{𝜏})-----------------------------------(3) 

 

𝐷𝐴_{𝜏}  =  [𝛼1( {1}/{𝐴{𝜏−1}}))  +  𝛼_2 (𝛥𝑅𝐸𝑉_{𝜏}  +  𝛼_3 (𝑃𝑃𝐸_{𝜏})  +  𝜈_{𝜏} ┤]  −  [𝛼1( {1}/{𝐴{𝜏−1}})  +

 𝛼_2 (𝛥𝑅𝐸𝑉_{𝜏}  −  𝛥𝑅𝐸𝐶_{𝜏})  +  𝛼_3 (𝑃𝑃𝐸_{𝜏}) ┤]---------------------------------------------------------- (4) 
 
Where 

TAτ = Total accruals in year τ scaled by lagged total assets in year τ-1 

DAτ = Estimated discretionary accruals in year τ 

NDAτ = Estimated non-discretionary accruals in year τ 

ΔREV = Revenues in year τ less revenues in year τ-1 scaled by total assets at τ-1 

ΔREC = Net receivables in year τ less net receivables in year τ-1 scaled by total assets at τ -1 

PPEτ = Gross property, plant, and equipment in year τ scaled by total assets at τ-1 

Aτ-1 = Total assets at τ-1 

α1, α2, α3 = Firm-specific parameters 

a1, a2, a3 = Ordinary least squares estimates of α1, α2, α3 

υτ = Measurement error in year τ 

 

Measures of Tax Avoidance 

Effective tax rates (ETRs) are key indicators of tax burdens relative to gross profits, incorporating tax shelters and incentives 

(Harris & Feeny, 2003; Rohaya et al., 2010). The public and policymakers widely use them to assess tax system neutrality 

and differentiate firms based on tax burdens (Harris & Feeny, 2003). This study calculates ETRs as current income tax 

expenses (excluding deferred tax expenses) divided by pretax income derived from firm-level financial statements. Tax 

expenses represent the numerator, reflecting a firm's income tax burdens, while pretax income is the denominator. 

 

Measures of Tax Incentive Recipient Status as Moderator 

This study used a dummy variable of "1" for the tax incentive recipient status and "0" for otherwise. MIDA's top 500 tax 

recipient list in 2017 was used as a reference for this study to determine the tax incentive recipient status of each participating 

firm in this study. 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

36 

Control Variables 

Real Earnings Management 

According to Roychowdhury (2006), normal cash flow from operation (CFO) is expressed as a linear function of sales and 

change in sales.   Abnormal cash flow from operation (CASHABS) refers to the subtraction of the actual CFO from the 

average level of CFO calculated using the estimated coefficient using the following cross-sectional regression for each 

industry and year: 

 
𝐶𝐹𝑂𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
= 𝑘1𝑡 (

1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘2 (

𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘3 (

𝛥𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡-------------------------------------------------------------(5) 

 

Meanwhile, production costs refer to the sum of costs of goods sold (COGS )and inventory changes. The overall model for 

production costs is expressed in the following: 

 

[
𝑃𝑅𝑂𝐷𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
= 𝑘1𝑡 (

1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘2 (

𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘3 (

𝛥𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘4 (

𝛥𝑆𝑎𝑙𝑒𝑠𝑖,𝑡−1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡---------------------------------------(6) 

 

The equation model is then developed to estimate the normal level of production costs, where COGS is modelled as a linear 

function of contemporaneous sales: 
𝐶𝑂𝐺𝑆𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
= 𝑘1𝑡 (

1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘2 (

𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡----------------------------------------------------------------------------------(7) 

 

In addition, inventory growth is modelled as follows: 

 

𝛥𝐼𝑁𝑉𝑖,𝑡 = 𝑘1𝑡 (
1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘2 (

𝛥𝑆𝑎𝑙𝑒𝑠𝑖,𝑡

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝑘3 (

𝛥𝑆𝑎𝑙𝑒𝑠𝑖,𝑡−1

𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡----------------------------------------------------------------(8) 

 

As for the curtailment of discretionary costs, the following cross-sectional models for each industry and year are estimated 

(Roychowdhury, 2006): 

 

𝑆𝐺&𝐴𝑖,𝑡 = 𝛽1 + 𝛽2 (
1

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝛽3 (

𝑆𝑎𝑙𝑒𝑠𝑖,𝑡−1

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡------------------------------------------------------------------(9) 

𝑅&𝐷𝑖,𝑡 = 𝛽1 + 𝛽2 (
1

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝛽3 (

𝑆𝑎𝑙𝑒𝑠𝑖,𝑡−1

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠𝑖,𝑡−1
) + 𝜖𝑖,𝑡------------------------------------------------------------------(10) 

 

Empirical Model 

A regression model was developed for this study to determine the influence of ETR (tax avoidance) on discretionary accruals 

(earnings management): 

 

𝐷𝐸𝑀 = 𝑎1𝐸𝑇𝑅 + 𝑎2𝑀𝐼𝐷𝐴 + 𝑎3𝐴𝑈𝐷𝐼𝑇 + 𝑎4𝐷𝐼𝑅𝐸𝐶𝑇𝑂𝑅 + 𝑎5𝐼𝑁𝑆𝑇𝐼 + 𝑎6𝑁𝑂𝑀𝐷𝐼𝑅𝐸𝐶𝑇𝑂𝑅 + 𝑎7𝐼𝑁𝐷𝐷𝐼𝑅𝐸𝐶𝑇𝑂𝑅 +
𝑎8𝐿𝐸𝑉 + 𝑎9𝑆𝐼𝑍𝐸 + 𝑎10𝐴𝐺𝐸 + 𝑎11𝐴𝐵𝑆𝑅𝐸𝑀_𝑃𝑅𝑂𝐷 + 𝑎12𝐴𝐵𝑆𝑅𝐸𝑀_𝐷𝐼𝑆𝐸𝑋𝑃 + 𝑎13𝐴𝐵𝑆𝑅𝐸𝑀_𝐶𝐹𝑂 + 𝜖----------------(11) 

 

Where 
DEM = The absolute value of discretionary accruals to measure earnings management 

ETR = The ratio of current income tax expenses divided by income before interests and taxes 

MIDA = A dummy variable of "1" for tax incentive recipient status and "0" for otherwise 

AUDIT = The dummy variable of "1" for Big Four audit firms and "0" for otherwise 

DIRECTORSHOLD = Managerial ownership by directors (in percentage) 

INSTI = Institutional ownership (in percentage) 

NO DIRECTOR = Size of the board of directors 

INDDIRECTOR = Number of independent directors 

LEV = Leverage, or specifically, the total debt at the end of the year divided by the total assets at the end of the year 

SIZE = The natural logarithm of total assets 

AGE = Age of the firm from the year incorporated to the year 2017 

ABSREM_PROD = The absolute value of real earnings management measure for abnormal production 

ABSREM_DISEXP = The absolute value of real earnings management measure for abnormal discretionary expenses  

ABSREM_CFO = The absolute value of real earnings management measure for abnormal cash flows 

 

 As shown in Equation (11), earnings management (DEM) was measured as this study's dependent variable.   MIDA, 

ETR, and the interaction variable of MIDA*ETR represented the tax avoidance measures, specifically for this study to 

determine whether the incentives to manage tax would significantly influence earnings management by managers.   

Furthermore, the analysis was expected to yield empirical evidence on whether engagement in tax avoidance would 

compromise the quality of financial reporting and whether the receipt of tax incentives would weaken the relationship 

between tax avoidance and earnings management.  

 

RESULTS 

Descriptive Statistics 

Table 2 presents the results of descriptive statistics for DEM (dependent variable), ETR and MIDA (main independent 

variables), and other control variables.  



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

37 

Table 2.   Descriptive statistics 

 
Descriptive Statistics 

  Number of Observations Minimum Value Maximum Value Skewness Kurtosis 

MIDA 202 0 1 1.242 -0.462 

ETR 202 0.0025 37 0.783 -0.639 

AUDIT 202 0 1 -0.428 -1.835 

DIRECTORSHOLD 202 0 66.37 2 3.356 

INSTI 202 0 69 3.03 12.302 

NOMDIRECTOR 202 4 15 0.43 0.077 

INDDIRECTOR 202 0 9 -0.074 1.894 

LEV 202 0 0.8 2.19 5.798 

SIZE 202 7.774 20.51 0.971 1.327 

AGE 202 3 191 2.047 7.586 

DEM 202 0 1.1748 1.465 0.767 

TOTALREM 202 0 1.96259 4.035 19.208 

ABSREM_PROD 202 0 1.20581 4.373 22.06 

ABSREM_DISEXP 202 0 0.81501 4.179 23.786 

ABSREM_CFO 202 0 0.43683 2.108 5.466 

Valid N (listwise) 202     

 

Correlation Matrix 

Table 3 displays the correlation matrix, revealing significant relationships among the variables. AGE correlates positively 

with ETR, LEV, and DEM, suggesting older firms tend to have higher effective tax rates leverage and engage in more 

earnings management. TOTALREM correlates positively with INSTI, SIZE, and DEM, indicating real earnings 

management links to institutional ownership, size, and earnings management.   Institutional ownership may curb earnings 

management, while larger firms have more resources for real earnings management. Lower ETRs are observed among firms 

with higher institutional ownership and real earnings management, while higher leverage is seen in firms with more 

institutional ownership. 

Additionally, firms with more non-executive directors tend to have more independent directors. Ownership 

appeared to engage in higher levels of real earnings management. The obtained results further indicated a higher number of 

non-executive directors among firms with higher levels of institutional ownership. Meanwhile, firms with more non-

executive directors demonstrated a higher propensity to have more independent directors. 

 

Table 3.   Correlation matrix 

 

Table 4.   Main Results 

 

Testing of H1 

This section presents the results of the H1 testing, specifically on the relationship between tax avoidance (measured by 

effective tax rate) and earnings management. In other words, this study determined whether tax avoidance would motivate 

firms to engage in earnings management. The obtained results are presented in Table 4. 

 

 

Correlations 

  (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) 

(1) ETR 1 -0.019 -0.120 0.013 -0.011 -0.112 0.069 0.177* -0.041 0.083 

(2) DIRECTORSHOLD -0.019 1 -0.110 -0.096 -0.178* 0.010 -0.133 0.024 -0.002 0.092 

(3) INSTI -0.120 -0.110 1 0.103 0.150* 0.242** 0.094 0.141* -0.065 -0.013 

(4) NOMDIRECTOR 0.013 -0.096 0.103 1 0.351** 0.086 0.132 -0.105 0.087 0.009 

(5) INDDIRECTOR -0.011 -0.178* 0.150* 0.351** 1 0.170* 0.170* 0.069 0.021 0.032 

(6) LEV -0.112 0.010 0.242** 0.086 0.170* 1 0.091 0.173* 0.022 0.088 

(7) SIZE 0.069 -0.133 0.094 0.132 0.170* 0.091 1 0.059 0.367** 0.143* 

(8) AGE 0.177* 0.024 0.141* -0.105 0.069 0.173* 0.059 1 0.141* 0.130 

(9) DEM -0.041 -0.002 -0.065 0.087 0.021 0.022 0.367** 0.141* 1 0.416*

* 

(10) TOTALREM 0.083 0.092 -0.013 0.009 0.032 0.088 0.143* 0.130 0.416** 1 

Notes: * denotes statistical significance at 0.05 level (two-tailed); ** denotes statistical significance at 0.01 level (two-tailed). 

Coefficients 

Model Items  Unstandardized Coefficients Beta Std. Error Standardized Coefficients Beta t Sig. 

1 

  

  

  

  

  

  

  

  

  

  

  

  

  

(Constant) -0.710 0.142  -5.016 0.000 

ETR -0.004 0.002 -0.118 -2.050 0.042 

MIDA -0.185 0.047 -0.237 -3.904 0.000 

AUDIT 0.060 0.040 0.088 1.510 0.133 

DIRECTORSHOLD -0.001 0.001 -0.028 -0.499 0.618 

INSTI -0.004 0.002 -0.115 -1.970 0.050 

NOMDIRECTOR 0.020 0.010 0.125 2.056 0.041 

INDDIRECTOR -0.013 0.015 -0.057 -0.903 0.368 

LEV -0.170 0.141 -0.072 -1.205 0.230 

SIZE 0.049 0.009 0.332 5.767 0.000 

AGE 0.002 0.001 0.166 2.821 0.005 

ABSREM_PROD 0.272 0.153 0.139 1.772 0.078 

ABSREM_DISEXP 0.213 0.255 0.066 0.833 0.406 

ABSREM_CFO 1.702 0.302 0.358 5.636 0.000 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

38 

Table 5.   Results of ANOVA (H1 and H2) 

 
Model Summary 

Model R R2 Adjusted R2 Std. Error of the Estimate 

1 .657a 0.432 0.393 0.259 

a. Predictors: (Constant), ABSREM_CFO, NOMDIRECTOR, ETR, AUDIT, DIRECTORS HOLD, INSTI, SIZE, AGE, MIDA, LEV, INDDIRECTOR, ABSREM_PROD, 

ABSREM_DISEXP 

ANOVAa 

Model  Sum of Squares df Mean Square F Sig. 

1 

  

  

Regression 9.622 13 0.740 11.000 .000b 

Residual 12.650 188 0.067   

Total 22.272 201    

a. Dependent Variable: DEM 

b. Predictors: (Constant), ABSREM_CFO, NOMDIRECTOR, ETR, AUDIT, DIRECTORS HOLD, INSTI, SIZE, AGE, MIDA, LEV, INDDIRECTOR, ABSREM_PROD, 

ABSREM_DISEXP 

 

Referring to these results, this study empirically demonstrated a statistically significant relationship between tax 

avoidance (ETR) and the magnitude of discretionary accruals (DEM) at the 0.01 level. The relationship was statistically and 

economically significant, with a negative correlation between ETR and the absolute value of discretionary accruals. In other 

words, lower ETR (indicative of higher tax avoidance) resulted in a higher magnitude of earnings management. Therefore, 

H1 was supported in this study. 

These findings highlight the potential motivations and mechanisms of tax avoidance influencing managerial 

conduct and financial reporting outcomes. This is consistent with the results from previous studies by Putri et al. (2016) and 

Desai and Dharmapala (2006, 2009), which similarly reported a relationship between tax avoidance and earnings 

management. Managers often exploit various tax avoidance strategies to manipulate earnings to benefit their interests rather 

than shareholders (Desai & Dharmapala, 2009; Olaniyi et al., 2020). The significant influence of tax avoidance on managers' 

adoption of earnings management strategies (Desai & Dharmapala, 2006, 2009; Desai et al., 2007) is highly plausible and 

justified. The incentive to engage in tax avoidance promotes the incentive to engage in earnings management, driven by the 

need for financial flexibility and risk mitigation (Desai & Dharmapala, 2006, 2009; Gunny, 2010). 

Tax avoidance strategies typically involve obfuscating transactions to acquire tax benefits without detection by tax 

authorities (Christensen & Murphy, 2004; Desai & Dharmapala, 2009; Goncharov & Zimmermann, 2006). Shareholders 

find it challenging to monitor managerial conduct effectively due to the need for more transparency in transactions, resulting 

in tax evasion. Firms' earnings are often manipulated to align with desired tax outcomes and yield favourable financial 

conditions for tax planning. Through earnings management, managers can cover up potential indications of aggressive tax 

planning and minimize the likelihood of scrutiny from tax authorities (Desai & Dharmapala, 2006, 2009). 

Conditions for earnings management are facilitated by tax expenses (Schipper, 1989), making tax expenses more 

susceptible to manipulation as part of firms' income management practices. These findings are statistically and economically 

significant, indicating substantial corporate governance and financial transparency implications. 

 

Testing of H2 

Referring to Table 5, this study observed a statistically significant negative relationship between tax incentive recipient 

status (MIDA) and the magnitude of discretionary accruals (DEM), supporting H2. The coefficient value of -0.237 indicated 

a 23.7% lower likelihood of tax incentive recipient firms engaging in earnings management than non-recipients. Control 

variables such as institutional ownership (INSTI), number of directors (NOMDIRECTOR), firm size (SIZE), firm age 

(AGE), and absolute value of discretionary accruals (ABSREM_PROD and ABSREM_CFO) were significantly related to 

discretionary accruals, consistent with previous studies (Beatty et al., 2002; Chen et al., 2010; Dechow et al., 1996; Fan & 

Wong, 2002; Klein, 2002). Managerial ownership (DIRECTORSHOLD), leverage (LEV), and a number of independent 

directors (INDDIRECTOR) showed no significant influence on discretionary accruals (Augustine & Dwianika, 2019; Park 

& Shin, 2004). This study demonstrates that tax avoidance negatively influences earnings management among Malaysian 

public firms, with tax incentive recipient firms showing a lower propensity for earnings management compared to non-

recipients. This raises the question of whether tax incentives motivate tax avoidance for lower tax burdens, as increased 

agency problems, litigation risks, and reputational harm might offset improved cash flows from tax avoidance. Tax incentive 

recipients might avoid aggressive tax planning to prevent reputational damage and regulatory scrutiny. The following 

section tests H2, examining the difference in tax avoidance between tax incentive recipients and non-recipient firms in 

Malaysia. 

 

Testing of H3 

Table 6 presents the independent samples t-test results on the difference in the ETRs between firms with MIDA status and 

non-MIDA status. In particular, firms with MIDA status recorded an average ETR of 10.911%, whereas firms with non-

MIDA status recorded an average ETR of 8.405%. Although both average ETRs were lower than the statutory tax rate of 

25%, it was evident that the receipt of tax incentives lowered the tax burdens for firms with MIDA status. However, the 

reduction in tax burdens was less substantial than that observed for firms with non-MIDA status. 

 

 

 

 

 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

39 

Table 6.   Results of independent samples t-test (H3) 

 
Group Statistics 

MIDA  N Mean Std. Deviation Std. Error Mean 

ETR 

  

1 48 10.911 9.008 1.300 

0 154 8.405 8.685 0.700 

Independent Samples T-Test 

  Levene’s Test for Equality of Variances                              T-Test for Equality of Means 

F Sig. t df Sig. 

ETR Equal variances assumed 1.043 0.308 1.730 200 0.085 

Equal variances are not 

assumed. 

  1.697 76.209 0.094 

Note: Significant at 0.10 level (two-tailed) 

 

Thus, providing tax incentives effectively reduces firms' tax burdens, making them less likely to engage in 

aggressive tax avoidance due to associated costs and risks. Tax incentive recipients achieve substantial tax savings with 

lower costs and risks than tax avoidance. These results highlight the relationship between tax incentives, tax avoidance, and 

earnings management, offering valuable insights for policymakers and regulators in designing tax incentive initiatives and 

monitoring tax avoidance practices. 

 

Additional Analysis: Moderating Effect of Tax Incentives 

The costs and risks of aggressive tax avoidance are typically higher than those associated with tax incentives. However, 

whether tax incentives strengthen or weaken this relationship remains unresolved. Hanlon and Slemrod (2009) found lower 

tax avoidance among firms receiving R&D tax incentives, suggesting that such incentives drive R&D spending and future 

earnings, reducing tax avoidance. Similarly, Goerke (2019) found that firms with robust CSR initiatives are less likely to 

engage in tax evasion due to reputational risks. These findings imply a potential moderating effect of tax incentives on the 

relationship between tax avoidance and earnings management. The moderating effect of tax incentives on the tax avoidance-

earnings management relationship has yet to be thoroughly explored. Tax incentive recipients manipulate earnings to meet 

incentive requirements, or the incentives mitigate this relationship due to lower costs and risks. This study examines this 

effect among Malaysian public firms, focusing on the interaction between ETR and MIDA and MIDA's influence on the 

ETR-DEM relationship. 

Three possible outcomes are considered: (1) tax incentives weaken the relationship between tax avoidance and 

earnings management; (2) tax incentives strengthen the relationship; (3) tax incentives do not affect the relationship. The 

third outcome may occur if firms face high pressure for both practices, weakening the influence of tax incentives. The study 

hypothesizes that tax incentives significantly moderate this relationship, as tax incentive recipients may view tax avoidance 

practices unfavourably. Additionally, firms might manipulate accounting figures to demonstrate strong financial 

performance for future tax incentives. Despite receiving tax incentives, the pressure to meet both requirements may motivate 

firms to engage in tax avoidance and earnings management.   Using the following empirical model, additional analysis on 

the moderating effect of tax incentives was conducted: 

 

DEM = a1ETR + a2MIDA + a3MIDA*ETR + a4AUDIT + a5DIRECTOR + a6INSTI + a7NOMDIRECTO+ 

a8INDDIRECTOR + a9LEV + a10SIZE + a11AGE + a12 ABSREM_PROD + a13ABSREM_DISEXP + a14ABSREM_CFO + 

ε------------------------------ (12) 

 

Table 6 presents the results of this study's additional analysis. With the coefficient value of -0.258, MIDA as a 

dummy variable exhibited a statistically significant influence on DEM at 0.01 level. With all other independent variables as 

control variables, the results revealed a significantly lower tendency to engage in discretionary accruals (earnings 

management) among firms classified as tax incentive recipients (MIDA = 1) than firms classified as non-tax incentive 

recipients (MIDA = 0) by a magnitude difference of 2,851 in DEM. These results reaffirmed the results of hypothesis testing 

for H2 and demonstrated the potential influence of tax incentives on firms' earnings management. Besides that, the results 

revealed the significant influence of control variables, specifically AUDIT, SIZE, and AGE, as well as ABSREM_PROD 

and ABSREM_CFO, on DEM, which were found to be in line with the results reported by prior studies (Park & Shin, 2004).   

The remaining control variables of DIRECTORSHOLD, LEV, INDDIRECTOR, and INSTI did not significantly influence 

DEM, which extended the current understanding of factors that influence earnings management. 

 

Table 7.   Results of ANOVA on the relationship between ETR and absolute value of discretionary accruals conditional to 

MIDA as dummy variable 

 
Model Summary 

Model R R2 Adjusted R2 Std. Error of the Estimate 

1 .658a 0.432 0.390 0.260 

a. Predictors: (Constant), ETR_MIDA, DIRECTORS HOLD, LEV, ABSREM_CFO, NOMDIRECTOR, AUDIT, SIZE, INSTI, AGE, INDDIRECTOR, ETR, ABSREM_PROD, 

ABSREM_DISEXP, MIDA 

ANOVAa 

Model  Sum of Squares df Mean Square F Sig. 

1 

  

  

Regression 9.629 14 0.688 10.173 .000b 

Residual 12.643 187 0.068   

Total 22.272 201    

a. Dependent Variable: DEM 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

40 

b. Predictors: (Constant), ETR_MIDA, DIRECTORS HOLD, LEV, ABSREM_CFO, NOMDIRECTOR, AUDIT, SIZE, INSTI, AGE, INDDIRECTOR, ETR, ABSREM_PROD, 

ABSREM_DISEXP, MIDA 

 
Coefficients 

Model  Standardized Coefficients Beta Sig. 

1 (Constant) -0.699  0.000 

 AUDIT 0.059 0.086 0.145 

 DIRECTORSHOLD -0.001 -0.031 0.595 

 INSTI -0.004 -0.113 0.058 

 NOMDIRECTOR 0.020 0.121 0.051 

 INDDIRECTOR -0.013 -0.056 0.376 

 LEV -0.161 -0.068 0.264 

 SIZE 0.049 0.332 0.000 

 AGE 0.002 0.162 0.009 

 MIDA -0.201 -0.258 0.005 

 ETR -0.005 -0.127 0.050 

 ABSREM_PROD 0.275 0.141 0.076 

 ABSREM_DISEXP 0.207 0.064 0.422 

 ABSREM_CFO 1.700 0.357 0.000 

 ETR_MIDA 0.002 0.031 0.755 

a. Dependent Variable: DEM 

 

The results on the interaction between ETR and ETR_MIDA further revealed the statistically significant and 

negative relationship between ETR and DEM (beta coefficient of -0.127) at 0.05 level. Thus, this study did not obtain 

adequate evidence to support the proposed hypothesis that the receipt of tax incentives significantly moderates the 

relationship between tax avoidance and earnings management. In other words, providing tax incentives has little impact on 

firms' engagement in tax avoidance and earnings management. The complexities of tax incentives, tax avoidance, and 

earnings management, the effects of different factors on various firms, sectors, and industries, as well as the strategic 

behaviours and conducts of businesses, have contributed to the difficulty of accurately determining the relationship of tax 

incentives, tax avoidance, and earnings management. Moreover, institutional pressures may compel firms to engage in tax 

avoidance, regardless of whether they receive tax incentives. On a similar note, Sánchez-Ballesta and Yagüe (2021) 

contended the discrete effects of the pressures associated with tax avoidance. They reported earnings on the relationship 

between tax avoidance and earnings manipulation. 

 

DISCUSSIONS 

This study investigates the relationship between tax avoidance, measured by the effective tax rate (ETR), and earnings 

management, measured by discretionary accruals (DEM), among Malaysian public firms. It also examines the impact of tax 

incentive recipient status on this relationship. The findings confirm a significant negative relationship between tax avoidance 

and earnings management, indicating that higher tax avoidance is associated with increased earnings manipulation. 

The negative relationship between tax avoidance and earnings management suggests that managers engage in 

opportunistic behaviour to maximize their utility at the expense of shareholders. These findings align with prior research by 

Desai and Dharmapala (2006), who highlight that tax avoidance strategies allow managers to manipulate financial outcomes 

in ways not immediately apparent to shareholders or regulators. By reducing the firm's tax liabilities, managers can free up 

resources for short-term financial targets or increased compensation, creating opportunities for earnings management. This 

pattern is consistent across different contexts, as observed in studies by Putri et al. (2016) and Desai and Dharmapala (2006).   

However, this study contradicts such studies as Delgado et al. (2023), who find a positive relationship between ETR 

indicators and discretionary accruals, suggesting that higher ETRs do not necessarily correlate with reduced earnings 

management. This contradiction may stem from differences in sample selection, measurement methods, or regional 

economic conditions.   Additionally, geographical variability in research findings further complicates the understanding the 

relationship between tax avoidance and earnings management. For example, Dhaliwal et al. (2004) and Blaylock et al. 

(2015) in the U.S. find a strong link between aggressive tax strategies and financial reporting, while Guenther et al. (2017) 

report a negative relationship, indicating different outcomes based on regional factors such as regulatory environments, 

corporate governance practices, and cultural differences. 

Further, the study reveals that tax incentive recipient firms are less likely to manage earnings than non-recipients.   

This finding is statistically significant and economically meaningful, suggesting that tax incentives may deter aggressive 

earnings management due to increased regulatory scrutiny and compliance requirements. This finding contributes to the 

literature on the impact of tax incentives, such as those by Okoth (2023) and Wang et al. (2024), but shows varied outcomes.   

While some studies find that tax incentives promote positive corporate behaviour and reduce tax avoidance, others suggest 

that tax incentives lead to increased earnings management to meet regulatory benchmarks. These compliance requirements 

encourage conservative accounting practices and improved internal controls, reducing the likelihood of earnings 

manipulation. This is supported by research from Guenther (1994) and Lin et al. (2016), as well as aligns with Armstrong 

et al. (2016) and Bauer et al. (2018), who found that external monitoring and oversight can mitigate earnings management. 

Nonetheless, the additional analysis shows that tax incentives do not significantly moderate the relationship 

between tax avoidance and earnings management.   Firms may still face pressure to manage earnings, so work on managing 

tax incentives is needed. The findings imply that while tax incentives can reduce earnings management, they are not strong 

enough to moderate the relationship between tax avoidance and earnings management. This suggests that other pressures, 

such as regulatory scrutiny and the need to present favourable financial outcomes, influence managerial behaviour. This 

study highlights the complex relationship between tax avoidance, earnings management, and tax incentives. While tax 

incentives can reduce earnings management, they are insufficient to moderate the relationship between tax avoidance and 



Ali et al., Bangladesh Journal of Multidisciplinary Scientific Research 9(2) (2024), 30-44

 

41 

earnings management, suggesting the need for more robust regulatory frameworks and effective corporate governance to 

mitigate these practices. 

 

CONCLUSIONS 

This study explores the relationship between tax avoidance, measured by the effective tax rate (ETR), and earnings 

management, measured by discretionary accruals (DEM), among Malaysian public firms while examining the impact of tax 

incentive recipient status on this relationship. The findings reveal a significant negative relationship between tax avoidance 

and earnings management, suggesting that higher tax avoidance is associated with increased earnings manipulation. This 

aligns with existing literature indicating that tax avoidance strategies allow managers to manipulate financial outcomes, 

thereby maximizing their utility at the expense of shareholders. 

A notable contribution of this study is that firms receiving tax incentives are less likely to engage in earnings 

management than non-recipients. This suggests that tax incentives deter aggressive earnings management due to increased 

regulatory scrutiny and compliance requirements. However, tax incentives do not significantly moderate the relationship 

between tax avoidance and earnings management despite this deterrence. This indicates that other pressures, such as 

regulatory scrutiny and the need to present favourable financial outcomes, continue to influence managerial behaviour. 

The unique contribution of this paper lies in its detailed analysis within the unique setting of Malaysian public 

firms, explicitly considering the tax incentive recipients' status data. This context provides new insights into how tax 

incentives can influence managerial behaviour regarding earnings management and tax avoidance. The study provides 

empirical evidence that, while tax incentives can reduce earnings management, they must be sufficiently strong to discourage 

the practice entirely when firms face significant pressures to reduce tax burdens and manage earnings. The theoretical 

implications of this study suggest that while tax incentives can reduce earnings manipulation to some extent, they are not a 

potent remedy for mitigating the adverse effects of tax avoidance in influencing earnings management. From a managerial 

perspective, the findings highlight the need for robust regulatory frameworks and effective corporate governance 

mechanisms to control managerial behaviour and enhance the transparency and reliability of financial reporting.   

Policymakers should carefully design tax policies that balance promoting economic growth with the need for financial 

integrity. 

This study's limitations include its focus on Malaysian public firms, which may limit the generalizability of the 

findings to other contexts.   Additionally, the study does not account for potential industry-specific effects or differences in 

corporate governance practices across firms.  Future research could address these limitations by exploring the relationship 

between tax avoidance and earnings management in different countries and industries. Longitudinal studies also provide 

insights into how changes in tax policies and economic conditions influence this relationship over time. 

 

 
Author Contributions: Conceptualization, S.M.A., M.N. and N.J.; Methodology, M.B.; Software, M.B.; Validation, S.M.A., M.N. and N.J.; Formal 

Analysis, S.M.A., M.N. and N.J.; Investigation, S.M.A., M.N. and N.J.; Resources, S.M.A., M.N. and N.J.; Data Curation, S.M.A., Writing – Original 
Draft Preparation, S.M.A., M.N. and N.J.; Writing – Review & Editing, S.M.A., M.N. and N.J.; Visualization, S.M.A.; Supervision, S.M.A.; Project 

Administration, S.M.A.; Funding Acquisition, S.M.A., M.N. and N.J. Author has read and agreed to the published version of the manuscript.  

Institutional Review Board Statement: Ethical review and approval were waived for this study because the research does not involve vulnerable groups 
or sensitive issues. 

Funding: The authors received no direct funding for this research. 

Acknowledgments: Not Applicable. 
Informed Consent Statement: Informed consent was obtained from all subjects involved in the study. 

Data Availability Statement: The data presented in this study are available upon request from the corresponding author.   Due to restrictions, they are not 
publicly available. 

Conflicts of Interest: The authors declare no conflict of interest.    

 

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http://creativecommons.org/licenses/by/4.0/
http://creativecommons.org/licenses/by/4.0/
http://creativecommons.org/licenses/by/4.0/

