Earnings Thresholds in Chinese High-Tech Enterprises: The Role of Corporate Income Tax Incentives

Abstract

To encourage corporate investment in innovation or R & D and to foster innovative firms, the Chinese government established standards for the certification of high-tech enterprises in 2008. Business entities that meet these standards are entitled to tax deductions. The criteria include the proportion of R & D expenses to sales exceeding a certain percentage in the prior 3 years among different sales in the current year. The purpose of this paper is to investigate whether this criteria influence management’s preferences for an earnings threshold. This study collects data from 2008 to 2018 from the CSMAR database. All of the 1932 listed high-tech enterprises are included, with a total of 7547 samples. The results indicate : sales of 50 - 200 million yuan in the current year and a proportion of R & D expenses to sales in the prior 3 years before manipulating sales or R & D expense; sales above 200 million yuan in the current year, and that most of these firms’ proportion of R & D expenses to sales before manipulating sales or R & D expenses achieved the required ratio to qualify as a high-tech enterprise. Specifically, the results suggest that 88.83% of the listed high-tech enterprises in China focus on R & D activities or innovations, regardless of whether they qualify as a high-tech enterprise according to the Chinese government. However, a few of the samples’ proportion of R & D expenses to sales are below 3% in the prior 3 years when their sales exceed 200 million yuan in the current year before the manipulation of sales or R & D expenses. Of these firms, half have a proportion of R & D expenses to sales exceeding 3% after the manipulation of sales or R & D expenses. Overall, the results also support the presence of prospect theory in Chinese-listed high-tech enterprises , because mangers tend manipulate earnings by adjusting sales or R & D expenses to obtain tax benefits.