This study investigates whether compensating chief executive officers and business-unit managers using after-tax accounting-based performance measures leads to lower effective tax rates, the empirical surrogate used for tax-planning effectiveness. Utilizing proprietary compensation data obtained in a survey of corporate executives, the relation between effective tax rates and after-tax performance measures is modeled and estimated using a two-step approach that corrects for the endogeneity bias associated with firms' decisions to compensate managers on a pre- versus after-tax basis. The results are consistent with the hypothesis that compensating business-unit managers, but not chief executive officers, on an after-tax basis leads to lower effective tax rates.

We assess the usefulness of deferred tax expense in detecting earnings management. Assuming greater discretion under GAAP than under tax rules, and assuming managers exploit such discretion to manage income upward primarily in ways that do not affect current taxable income, then such earnings management will generate book-tax differences that increase deferred tax expense. Our results provide evidence consistent with deferred tax expense generally being incrementally useful beyond total accruals and abnormal accruals derived from two Jones-type models in detecting earnings management to avoid an earnings decline and to avoid a loss. Only total accruals is incrementally useful in detecting earnings management to meet analysts' earnings forecasts. Deferred tax expense is more accurate than the accrual measures in classifying firm-years as successfully avoiding a loss, whereas no one measure is more accurate in classifying firm-years as avoiding an earnings decline or meeting analysts' forecasts.