The Effect of Institutional Factors on Discontinuities in Earnings Distribution : Public Versus Private Firms in Japan

Previous studies have shown that, compared with earnings distributions in other countries, there are clear discontinuities at zero in the distribution of earnings levels in Japanese firms (Thomas et al. 2004; Suda and Shuto 2007; Shuto 2009). We predict that two unique institutional factors in Japan — (1) the alignment between financial and tax accounting, and (2) the tight relationship between firms and their banks — cause the discontinuities in earnings distribution. Consistent with this prediction, we find that firms with high marginal tax rates and tight relationships with their banks are more likely to manage earnings to report slightly positive earnings. We also find that this relationship is more pervasive for private firms than public firms. We contribute to the literature by examining a significant research setting that has features of both institutional factors and loss-avoidance behaviors to enable deeper consideration during hypothesis development