“An investigation of the value relevance of deferred tax: the mediating effect of earnings management”

There is an academic discussion about the value relevance of deferred tax, which aims to find out the effect of deferred tax on the investors’ decisions. In light of this discussion, the first question is about the impact of deferred tax on management practices to manipulate earnings, which is called earnings management, the second question is about the value relevance of earnings management, the third question is about the value relevance of deferred tax, and the fourth question is about the mediating effect of earnings management. The paper focuses on listed firms in the Egyptian Stock Exchange (EGX), especially firms that were recorded in EGX 100, for six-year period (2013–2018) for 107 firms and 642 completed observations. The findings are as follows: management uses deferred tax to manipulate earnings, since an increase in deferred tax amounts increases earnings management practices; there is no value relevance of earnings management, which means earnings management practices do not affect the investors’ decisions; there is value relevance of deferred tax, which confirms that de- ferred tax is one of the determinants that affect the investors’ decisions; there is no value relevance of deferred tax through earnings management as a mediator variable since investors are not interested in earnings management practices to make their investment decisions. This paper investigates the relationship between deferred tax, earn- ings management, and value relevance in the Egyptian context.


INTRODUCTION
Deferred tax appears as a result of the temporary differences between the accounting standards and the tax regulations applied. This difference is called the fiscal correction, which could be positive when the tax burden calculated according to accounting standards is not equal to the tax burden under law, which is called Deferred Tax Assets (DTAs), or could be negative when the tax burden according to accounting standards is higher, which is called Deferred Tax Liabilities (DTLs) (Jamaluddin, 2008).
Tax system in Egypt is regulated by Egyptian law, which was issued in 2005 to control the corporation tax roles. However, Egyptian listed firms are regulated by Egyptian Accounting Standards (EASs), which were issued for the first time in 1996, updated in 2006, then re-updated in 2016 since the Egyptian tax law does not fully match with EASs, so deferred tax has risen in Egypt (Salah, 2019).
In light of interest in controlling temporary difference of tax burden between accounting treatments and Egyptian tax law, which is referred to deferred tax, Egyptian Accounting Standards setters issued EAS 24 to address the accounting treatment for income tax to achieve some objectives; one of them is supporting the recognition of the deferred tax (IAS 12, 2006). However, some literature reviews mention the inadequate disclosure in deferred tax according to this standard; some firms' managements use this inadequate disclosure in deferred tax to manipulate earnings (Salah, 2019). They expect to reduce paid tax and effect on investors' decisions by increasing their cash flow and enhancing the reported results related to their firms. Therefore, this paper aims to investigate the effect of deferred tax on earnings management practices.
According to the agency theory, there is a conflict of interest between the related parties (principal), such as shareholders, and management as the party of interest (agent). Related parties are interested in getting a real output about their firm performance; however, management tries to maximize its interest through getting related parties' satisfaction by providing the related parties, especially shareholders, with information through financial statements to enhance management image, which is called "earnings management" (Mulyani, Titisari, & Dewi, 2018). It can be achieved through some tools; one of these tools is "deferred tax." Management can use deferred tax to manipulate earnings by changing the components of DTAs or DTLs, which affect the value of Deferred Tax Expenses (DTEs) (Phillips et al., 2003), which is called tax planning (Mulyani et al., 2018). Besides, recorded DTAs are used to reduce the income tax. However, DTEs increase it since management can use DTEs to manipulate earnings (Jamaluddin, 2008;Mulatsih, Dharmayanti, & Ratnassari, 2019). In other words, DTEs give a chance to delay income and speed up expenses to save tax (Mulatsih et al., 2019). Moreover, DTEs provide management with a unique chance to increase income without paying extra taxes in the same period (Mills & Newberry, 2001;Dhaliwal, Gleason, & Mills, 2003;Wijayanti, 2015).
The earnings management practices are reflected in related parties' decisions, which can be expressed by "value relevance of accounting information," besides, the effect of deferred tax on these decisions is called "value relevance of deferred tax." The paper is divided into five sections: section 1 shows the literature review and hypotheses development; section 2 presents the research methodology; section 3 provides the hypotheses testing and results; section 4 is related to discussion; last section presents the conclusion. This discussion indicates a deep debate on the value relevance of deferred tax. Therefore, the main question of this paper is, "What is the effect of deferred tax and earnings management practices on investors' decisions?" Consistent with this question, the paper investigates a mediation effect of earnings management on the relationship between deferred tax and both share prices and market value of equities. The literature review can be divided into three groups.

Deferred tax and earnings management practices
Previous studies on the relationship between deferred tax and earnings management practices are divided into two groups: the first group confirms a significant relationship between them. Bauman, Bauman, and Halsey (2000) use a sample of listed firms in the Fortune 500 to test the relationship between earnings management and DTAs valuation allowance. They confirm deficiency in current deferred tax, which leads to increased disclosure. Phillips Regarding the last studies, there is a debate on the relationship between deferred tax and earnings management practices. Hence, the paper investigates this relationship. The hypothesis is as follows: H1: Deferred tax has a significant relationship with earnings management.

The value relevance of earnings management
Previous studies related to value relevance of earnings management practices are divided into two groups: the first group of studies confirms a significant relationship between them. Shan (2015) uses a sample of listed firms in the Shanghai SSE 180 to investigate whether earnings management reduces share prices; they confirm that share prices are decreased for the firms which have more earnings management practices. Callao, Cimini, and Jarne (2016) use a sample of European listed firms to assess and compare value relevance of accounting numbers in firms that experienced earnings management behaviors. They confirm the value relevance of earnings is low for firms that their management make more practices to manipulate earnings.
Altintas, Sari, and Otluoglu (2017)  To the best of researchers' knowledge, no study has investigated the effect of earnings management practices as a mediator on the relationship between both deferred tax and share prices and market value of equities, as value relevance proxies. Hence, the paper is designed to examine the indirect effect of deferred tax on share prices and market value of equities through these practices. Therefore, the following hypothesis is: H3: The value relevance of deferred tax is mediated by earnings management practices.

The model
To investigate the hypotheses, which are related to the mediating role of earnings management between deferred tax and value relevance, the relationship among the main study variables is represented in Figure 1.  Table 2 introduces descriptive statistics for all study variables.

Data analysis
The data were processed using Structural Equation Modeling (SEM) method based on Partial Least Squares (PLS) since these data were processed by SmartPLS software.

Model goodness-of-fit
To assure that last model has results that can be trusted and generalized, the researchers test the goodnessof-fit and get results that are presented in Table 3.  Table 3 indicates that the research model is fit and easy to interpret.

Outer model assessment (measurement model)
The results obtained from the convergent validity test are presented in Table 4. Table 4 shows the value of the loading factor (convergent validity) of each indicator, since having a statistical t-value of > 1.96 means valid indicators and all t-values in this table, so all indicators are valid. Table 5 presents the results obtained from the discriminant validity test.  Table 5 shows that all indicators making up each variable (the values in bold) meets the discrimi-nant validity since it has the largest outer loading value for the variable it formed only. Table 6 represents R-square to judge a goodness-fit of the model.  Based on Q 2 , the amount of variability of the research data, which could be explained by the structural model, was 36.1% since the structural model in the study has a good fit. Table 7 shows the test results with bootstrapping of the PLS analyses.

RESULTS
According to Table 7, the obtained results are presented as follows: 1. The relationship between the deferred tax and earnings management practices can be obtained from line 1 since the path coefficient is 0.420 with a t-value of 4.403 is higher than 1.96, which means that there is a positive and significant relationship between deferred tax and earnings management. So the first hypothesis (H1) is accepted. The result indicates a significant relationship, which is not consistent with Mudjiyanti (2018), Purnamasari 2. Value relevance of earnings management can be obtained from line 2 since path coefficient is -0.081 with a t-value of 1.381, which is lower than 1.96, which indicates an insignificant relationship between earnings management practices and both share prices and market val-

DISCUSSION
The paper has one main objective, which is to analyze the effect of deferred tax and earnings management practices on the investors' decisions, which are reflected in share prices and market value of equities. This objective is divided into four sub-objectives: the first is investigating the effect of deferred tax on these practices, the second is investigating the value relevance of these practices, the third is investigating the direct value relevance of deferred tax, which concerns a direct relationship between deferred tax and both share prices and market value of equities, the fourth concerns an indirect relationship between the last two variables through earnings management practices, which can be done by verifying the mediation effect of these practices in value relevance of deferred tax.
Regarding the first sub-objective, Table 7 indicates that management uses deferred tax information to manipulate earnings since management practices chances to manipulate earnings increase when deferred tax expenses or net deferred tax assets increases.
Regarding the second sub-objective, Table 7 indicates no value relevance of earnings management practices, which means that these practices do not affect the investors' decisions (or preference), the reason of this result is successful of EAS, either were issued in 2006 or 2016, to reduce the effect of these practices on firms' performance.
Regarding the third sub-objective, Table 7 indicates direct value relevance of deferred tax, since the relationship between deferred tax and share prices and market value of equities is negative and direct. This result confirms that shareholders or investors' decisions (or preference) are affected by deferred tax information, which confirms that deferred tax information, either deferred tax expenses or net deferred tax assets, is one of some determinants that affect the investors' decisions.
Regarding the fourth sub-objective, Table 7 indicates no value relevance of deferred tax through earnings management practices as a mediator variable, despite a direct value relevance of deferred tax, as referred in the third objective. There is no indirect value relevance of deferred tax through earnings management practices, since investors are not interested in these practices to make their investment decisions. However, they are interested in deferred tax information, either DTE or N ET-DTL s.
Finally, deferred tax introduces relevant information to investors' decisions (or preference). However, earnings management practices do not significantly affect these decisions. Besides, these practices do not significantly affect the value relevance of deferred tax information.

CONCLUSION
Many literature reviews focus on the value relevance of deferred tax. This paper is interested in investigating it with concentrating on the mediation effect of earnings management on the relationship between deferred tax and both share prices and market value of equities for Egyptian listed non-financial firms.
For available data of 107 listed firms in EGX 100 from 2013 to 2018, which include 642 completed observations, the finding indicates the following: (1) management uses deferred tax expenses or net deferred tax assets to manipulate earnings through its positive relationship between deferred tax information and earnings management practices, which means management has a good environment to manipulate earnings if its firm has higher deferred tax expenses or net deferred tax assets, which gives a guideline to predict earnings management practices with regard to deferred tax information; (2) investors' decisions, which are expressed by both share prices and market value of equities, are affected by earnings management practices due to successful EAS to reduce the effect of these practices; (3) investor's decisions are affected by deferred tax information since investors use deferred tax information to make suitable decisions; in other words, deferred tax expenses and net deferred assets affect the investors' decisions (or preference) negatively; (4) earnings management practices have a significant and mediation role in the relationship between deferred tax and both share prices and market value of equities, which means that management does not use deferred tax to manipulate earnings to affect the investors' decisions (or preference).
The paper introduces three contributions: (1) management uses deferred tax to manipulate earnings; (2) management depends on the value relevance of deferred tax to affect the investors' decisions; (3) there is no mediation effect of earnings management practices on value relevance of deferred tax.
For future studies, researchers suggest concentrating on the effect of deferred tax and its proxies on audit quality, social responsibility, and sustainability. Moreover, researchers suggest testing the moderator effect of earnings management practices on the value relevance of deferred tax. Besides, researchers suggest re-investigating the mediation effect of earnings management practices on the value relevance of deferred tax with applying in a sample of different countries, either advanced or emerging markets, to analyze market nature of this investigation.