Understanding what happens when accounting books and tax returns don’t match—and why it matters for investors, regulators, and the future of financial transparency.
Introduction: The Gap That Tells a Story
When a company’s financial statements show one profit figure while its tax return shows another, accountants call this a “book-tax difference.” While some divergence between accounting income and taxable income is normal and expected, unusually large gaps can signal something more troubling: potential earnings manipulation.
A recent study published in the European Accounting Review investigates this phenomenon among firms listed on the Athens Stock Exchange from 2012 to 2021—a period that encompasses some of Greece’s most economically turbulent years. The research reveals important insights into how book-tax differences relate to financial reporting quality and what happens when capital controls disrupt normal market functioning.
Setting the Scene: Greece’s Economic Turbulence
To understand the significance of this research, we need to appreciate the context. Greece experienced one of the most severe sovereign debt crises in modern European history, leading to significant economic restructuring and the imposition of capital controls in June 2015.
The capital controls were implemented when negotiations with creditors collapsed and the European Central Bank declined to increase emergency liquidity assistance for Greek banks. Cash withdrawals from ATMs were limited to just €60 per day, and the Athens Stock Exchange was forced to close. The exchange lost more than 16% in its first day of trading after reopening, with certain bank stocks plummeting 30%.
These controls caused a drastic reduction in liquidity and an increase in investment uncertainty, with negative effects transmitted directly into real economic activity. The restrictions remained in place, gradually easing, until their complete removal on September 1, 2019.
This economic upheaval created a unique environment for studying financial reporting behavior—one where companies faced extraordinary pressures and where the normal functioning of capital markets was severely disrupted.
What Are Book-Tax Differences and Why Do They Matter?
Before diving into the findings, let’s understand what book-tax differences actually represent.
Book-tax differences arise because financial accounting rules afford managers more flexibility and discretion in reporting than tax accounting rules. Companies prepare two sets of financial calculations: one following Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) for shareholders and investors, and another following tax regulations for government authorities.
These differences fall into two categories:
- Permanent differences affect income calculation for either tax or financial reporting purposes, but never both
- Temporary differences arise from timing discrepancies between the two reporting systems
The rationale for using book-tax differences as a quality signal lies in the notion that taxable income is subject to more rigid rules and offers less managerial discretion than financial reporting. When the gap between the two grows unusually large, it may indicate that managers are exercising discretion in ways that don’t reflect true economic performance.
The Study’s Key Findings
Finding 1: Larger Book-Tax Differences Link to More Earnings Manipulation
The research finds that book-tax differences are positively associated with discretionary accrual-based earnings management among Greek listed firms. In simpler terms, companies with larger gaps between their book income and taxable income show stronger signs of manipulating their reported earnings through accounting choices.
This aligns with broader research suggesting that discretionary accruals are acknowledged to be proxies for earnings management, and firms in the negative earnings group are more involved in earnings management activity.
Finding 2: Extreme Profit Patterns
Firms with larger book-tax differences tend to report either high profits or significant losses—they cluster at the extremes rather than showing moderate performance. This pattern is consistent with managers using accounting discretion to hit earnings targets (either inflating profits to meet expectations or taking “big bath” write-offs during bad years to improve future comparisons).
Finding 3: Mixed Results for Real Earnings Management
While the association with accrual-based manipulation is clear, the impact on real earnings management measures is less consistent. This distinction is important because these represent different manipulation strategies.
Accrual-based earnings management is conducted by deferring expenses until a later period or by realizing sales before the actual delivery, while real earnings management involves changing actual business activities—like cutting research spending or delaying maintenance—to hit financial targets.
When accounting flexibility is limited, firms tend to resort to real earnings management, and vice versa. The Greek context, with its particular regulatory environment and economic pressures, may have influenced which manipulation strategies firms found most accessible.
The Capital Controls Effect
Perhaps the most intriguing aspect of this research involves examining how the 2015 capital controls affected these relationships.
The study finds that while capital controls don’t systematically alter the fundamental relationship between book-tax differences and financial reporting quality, they do have notable effects:
- Capital controls increased accrual-based earnings management: When normal financial operations were restricted, companies appear to have relied more heavily on accounting choices to manage their reported results.
- Capital controls constrained certain real earnings management practices: With cash flows restricted and business operations disrupted, companies had fewer opportunities to manipulate earnings through real activities like timing discretionary expenditures.
This finding makes intuitive sense. The capital controls had significant negative effects on investment decisions, competitiveness abroad, ability to raise new capital, and liquidity. When you can’t move money freely or execute normal business transactions, your options for manipulating results through operational decisions become limited—but accounting choices remain available.
The Greek Accounting Context
Understanding this research also requires appreciating Greece’s unique accounting environment. All listed Greek companies are required to prepare their financial statements under IFRS. Greece made the transition to IFRS mandatory for listed companies in 2005 as part of broader EU requirements.
Research on this transition has produced mixed findings. IFRS adoption reduced book-tax conformity in Greece, thereby releasing financial income from tax implications. Before IFRS, Greek accounting was more closely aligned with tax reporting, which provided a natural constraint on earnings manipulation—if you inflated your book income, your tax bill went up accordingly.
Within a weak legal enforcement environment such as in Greece, the auditor’s effort to ensure accounting quality is motivated by reputation costs. Studies have shown that larger audit firms, facing greater potential reputational damage, tend to produce higher quality audits in this environment.
The broader research picture suggests that IFRS adoption by itself is not sufficient to achieve a high level of accounting quality, reduce earnings management, or increase tax compliance. The institutional environment, enforcement mechanisms, and incentive structures all play crucial roles.
Implications for Different Stakeholders
For Investors
This research provides important signals for those analyzing Greek equities or companies in similar emerging market contexts:
- Watch the book-tax gap: Unusually large differences between reported accounting income and estimated taxable income warrant closer scrutiny.
- Consider the earnings pattern: Companies reporting consistently extreme results (very high profits or steep losses) may be more likely to be managing earnings.
- Factor in macro conditions: During periods of financial stress or capital restrictions, be especially attentive to accounting quality concerns.
For Regulators and Policymakers
The findings highlight several policy considerations:
- Book-tax differences as a monitoring tool: Tax authorities and securities regulators could use book-tax difference analysis as a screening mechanism to identify companies warranting closer examination.
- Crisis period vigilance: During economic disruptions, regulators may need heightened attention to financial reporting quality, as the research suggests accrual-based manipulation increases during such periods.
- Enforcement matters: The research indirectly underscores that accounting standards alone don’t guarantee quality—tax authority enforcement strengthens financial reporting quality and decreases tax avoidance.
For Auditors
The study reinforces the importance of:
- Scrutinizing large or unusual book-tax differences
- Understanding client-specific incentives for earnings management
- Maintaining professional skepticism during periods of economic stress when manipulation pressures may be elevated
The Broader Debate: Should Book and Tax Reporting Align?
This research touches on a longstanding debate in accounting: should there be greater conformity between book income and taxable income?
Proponents of increased book-tax conformity suggest it will simultaneously reduce aggressive financial reporting and abusive tax sheltering. Opponents argue that the information required by financial statement users is substantially different from that required by taxing authorities.
The evidence from Greece and elsewhere suggests that the relationship is nuanced. Earnings quality appears to be lower when book-tax conformity is higher, even though conformity may restrain managers from using their discretion to report earnings opportunistically.
In other words, giving managers some flexibility to convey private information about their company’s true performance may outweigh the risks that some managers will abuse that discretion. One-size-fits-all rules that eliminate discretion might reduce manipulation but could also reduce the informativeness of financial statements.
Limitations and Future Directions
Like all research, this study has limitations worth noting:
- Single-country focus: While the Greek context provides a unique natural experiment with capital controls, findings may not generalize to all markets.
- Measurement challenges: Discretionary accruals are acknowledged to be noisy proxies for earnings management. Distinguishing between legitimate accounting choices and manipulation remains inherently difficult.
- Time period: The 2012-2021 period, while capturing important events, represents specific economic conditions that may not persist.
Future research might examine how these relationships have evolved as Greece’s economy has stabilized, whether similar patterns emerge in other countries facing capital controls or financial crises, and whether specific regulatory interventions can effectively address the earnings management patterns identified.
Conclusion: The Signal in the Gap
The gap between what companies report to shareholders and what they report to tax authorities is more than an accounting technicality—it’s a window into corporate behavior and incentives. The research from Greece demonstrates that larger book-tax differences correlate with signs of earnings manipulation, particularly during periods of economic stress.
For anyone seeking to understand the true performance of a company, these findings reinforce an important lesson: look beyond the headline numbers. Examine the relationship between reported profits and taxable income. Consider the economic context and the pressures management faces. And remember that during times of crisis, when accurate information is most valuable, the incentives to distort that information may be at their strongest.
In an era of global capital flows and international financial reporting standards, understanding these dynamics isn’t just academic—it’s essential for investors, regulators, and anyone who relies on financial statements to make decisions.
References
- Floropoulos, S., Tsipouridou, M., & Spathis, C. (2025). Financial Reporting Quality in Greece: The Role of Book-Tax Differences and Capital Controls. European Accounting Review. https://doi.org/10.1080/17449480.2025.2588262
- Floropoulos, S., Tsipouridou, M., & Spathis, C. (2024). Book-tax conformity and earnings management: A research agenda. Journal of International Accounting, Auditing and Taxation, 54, 100590.
- Atwood, T.J., Drake, M.S., & Myers, L.A. (2010). Book-tax conformity, earnings persistence and the association between earnings and future cash flows. Journal of Accounting and Economics, 50(1), 111-125.
- Dimitropoulos, P.E., Asteriou, D., Kousenidis, D., & Leventis, S. (2013). The impact of IFRS on accounting quality: Evidence from Greece. Advances in Accounting, 29(1), 108-123.
- Karampinis, N.I. & Hevas, D.L. (2013). Effects of IFRS Adoption on Tax-induced Incentives for Financial Earnings Management: Evidence from Greece. The International Journal of Accounting, 48(2), 218-247.
- Mamatzakis, E., Pegkas, P., & Staikouras, C. (2022). The impact of debt, taxation and financial crisis on earnings management: the case of Greece. Managerial Finance, 48(9/10), 1392-1409.
- Tsipouridou, M. & Spathis, C. (2012). Earnings management and the role of auditors in an unusual IFRS context: The case of Greece. Journal of International Accounting, Auditing and Taxation, 21(1), 62-78.
This blog post synthesizes academic research for a general audience interested in financial reporting, accounting quality, and corporate governance. The views expressed are intended to explain research findings and do not constitute investment advice.
