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

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. How to cite this paper: Liu, Z. J. (2022). Earnings Thresholds in Chinese High-Tech Enterprises: The Role of Corporate Income Tax Incentives. Modern Economy, 13, 223240. https://doi.org/10.4236/me.2022.133014 Received: January 5, 2022 Accepted: March 7, 2022 Published: March 10, 2022 Copyright © 2022 by author(s) and Scientific Research Publishing Inc. This work is licensed under the Creative Commons Attribution International License (CC BY 4.0). http://creativecommons.org/licenses/by/4.0/ Open Access


Earnings Thresholds in Chinese High-Tech Enterprises: The Role of Corporate Income Tax Incentives Zhenjia Liu
School of Accounting and Finance, Tan Kah Kee College, Xiamen University, Xiamen, China

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.

Introduction
Between 1995 and 2010, the total output value of China's high-tech industry and the proportion of GDP contributed by this industry continued to rise, thereby continually strengthening its impetus function for the national economy (Guo & Wang, 2013). The economic backbone of China is transforming from traditional industries to the high-tech industry. Compared with firms in traditional industries, those in the high-tech industry usually require to strengthen innovation through R & D policy.
Governments support private R & D investment through R & D policy, which either directly allocates public R & D resources through grants or procurement (i.e., government R & D grants) or provides indirect support through tax incentives (i.e., tax deductions or credits). Under Chinese corporate income tax law, high-tech enterprises have a 15% tax rate, and the statutory tax rate is 25%. In China, high-tech enterprises must meet the standards for certification as a high-tech enterprise as established in 2008 by the Ministry of Science and Technology, the Ministry of Finance, and the State Administration of Taxation. The related requirements are as follows: 1) An enterprise in China must have obtained intellectual property (i.e., technology) for a product through transfer, purchase, independent R & D, or a contribution in the past 3 years or must have obtained a franchise more than 5 years ago. 2) The related technology or service of major product is related with electronic and telecommunications, aircraft and spacecraft, materials, medicine and pharmaceuticals, energy, technology services and advanced technology, or environmental protection. 3) The proportion of employees conducting R & D activities or technology innovation to total staff is not below 10% in any year. 4) The proportion of R & D expenses to sales is not below 6% in the prior 3 years if sales are below 50 million yuan in the current year; the proportion of R & D expenses to sales is not below 4% in the prior 3 years if sales are 50 -200 million yuan in the current year; and the proportion of R & D expenses to sales is not below 3% in the prior 3 years if sales are more than 200 million yuan in the current year (Each high-tech enterprise certification is valid for a period of up to 3 years. Re-examination is conducted in each year of the certification period; if the proportion of R & D expenses to sales does not meet a given level as specified in a given certification year, no tax deduction is offered in that year). 5) The proportion of sales of advanced technology products or services to total sales is not below 60% in the current year. 6) The enterprise has higher innovation ability and meets the related innovation criteria. However, according to the above rule, items 3, 5, and 6 are not be disclosure strictly; thus, outsiders make obtaining these data more difficult.
Empirical literature has investigated the effects tax incentives on firm earnings management (Mulyadi & Anwar, 2015;Mulyadi et al., 2013;Kapoutsou et al., 2015;Maydew, 1997). The purpose of this paper is to examine whether managers at these companies manage earnings by manipulating sales or R & D expenses in order to qualify as a high-tech enterprise (i.e., the proportion of R & D expenses to sales is not below 6%, 4%, 3%) and receive the associated tax benefits. Previous research has provided mixed evidence on the relative importance of three earnings thresholds that managers seek to achieve: avoiding losses, avoiding earnings declines and avoiding negative earnings surprises. We established the earnings thresholds by examining the meet the standards for certification as a high-tech enterprise as established in 2008 (i.e., the proportion of R & D expenses to sales is above 6%, 4%, 3%) and examined managers make decisions by focusing on the value from gains (i.e., tax incentives) with a certain reference point (i.e., the prospect theory).
This paper contributes to the literature on the criteria influence management's preferences for an earnings threshold and adopts the aforementioned theories (i.e., prospect theory). The results indicate that the listed high-tech enterprises in China are 88.83% firms and included with 6704 samples, pre-managed R & D expenses to pre-managed sales above 4%, 3% in the prior 3 years among different sales in the current year (include proportion of R & D expenses to sales was above 4% in the prior 3 years when sales from 50 million to 200 million in the current year before manipulating sales or R & D expenses). The empirical results also suggest that 843 samples' proportion of R & D expenses to sales was below 3% in the prior 3 years when sales were above 200 million yuan in the current year before manipulating sales or R & D expenses, and half of them exhibited a proportion of R & D expenses to sales above 3% after manipulating sales or R & D expenses to obtain tax credit. The article is organized as follows. Section 1 presents a brief review of the introduction. Section 2 presents a brief review of the related literature. Section 3 details the research design, sample selection procedure, and model development. Section 4 presents our empirical findings. Section 5 contains a summary and conclusion.

Earnings Management
The literature shows that managers can manage earnings in two ways. First, managers can exercise discretion over accrual choices to reach a desired level of earnings (referred to as accrual-based earnings management; AEM). Accrualbased earnings management includes discretionary accrual items (Dechow et al., 1995), discretionary current accruals (Louis, 2004), and discretionary working capital accruals (Matsumoto, 2002). The method measures discretionary accruals by examining some firm-specific characteristics.
Second, managers can manage earnings by real operating decisions (referred to as real-based earnings management; REM). These actions deviate from nor-mal business practices, with the primary objective of misleading stakeholders on underlying economic performance. Other researchers argue that to change reported earnings, managers do not necessarily resort to playing around with accounting methods and estimations, and instead may change real operation decisions such as cash flow from operations, production costs, discretionary expenditure (Roychowdhury, 2006;Gunny, 2010); R & D expenditure (Seybert, 2010), and sales manipulation (Ge & Kim, 2014;Stubben, 2010).
Generally, real-based earnings management is viewed more negatively than is accruals-based earnings management (Roychowdhury, 2006;Cohen & Zarowin, 2010) because distorting cash flow through real operation-manipulating activities (Kim & Sohn, 2013) and causes increases noise or errors in earnings, reduces investor expectations on future cash flow levels (Graham et al., 2005;Roychowdhury, 2006;Cohen & Zarowin, 2010). In addition, this approach deviates from optimal business operations, hides a firm's unmanaged earnings, and can be detrimental to a firm's long-term profitability and competitive advantages (Cohen & Zarowin, 2010;Zang, 2012). More seriously, REM is opaque to outside stakeholders (Graham et al., 2005;Zang, 2012) and internal monitors, such as the board and audit committee; accordingly, REM is difficult to detect because it might not be curtailed by good governance mechanisms, and external investors experience difficulty when evaluating firm performance (Kim & Sohn, 2013).
Substantial evidence suggests a significant discontinuity (i.e. a kink) in the distribution of various earnings measures. Degeorge et al. (1999) note that "distribution approach" is effective in detecting earnings management at the relevant thresholds.
Furthermore, empirical studies find that firms engage earnings management to meet earnings benchmarks through accrual items or real activities (Burgstahler & Eames, 2006;Hansen, 2010;Sun & Rath, 2012;Mitra et al., 2013). Hansen (2010) suggests that firms with small losses may profit through earnings management. Chen et al. (2010) report that more firms manage earnings to avoid earnings decreases. Chen et al. (2010) show that firms attempt to meet analyst earnings forecasts.  showed that corporate managers have incentives to report earnings that surpass analyst forecasts, because these benchmark-beating earnings elicit both a positive stock market response and several benefits for managers, whereas earnings that miss forecasts can cause a negative stock market response, with damaging consequences for managers and the firm itself.

Earnings Thresholds through Manipulate R & D Expenditure and Sales
Under Chinese corporate income tax law, high-tech enterprises have a 15% tax rate, and the statutory tax rate is 25%. In China, high-tech enterprises must meet the standards for certification as a high-tech enterprise as established in 2008 by the Ministry of Science and Technology, the Ministry of Finance, and the State Administration of Taxation. The standards for the certification of a high-tech enterprise stipulate that the proportion of R & D expenses to sales is not below 6%, 4%, or 3% in the prior 3 years for firms with sales below 50 million yuan, of 50 -200 million yuan, or more than 200 million yuan in the current year, respectively.
Other researchers argue that to change reported earnings, managers may change real operation decisions such as sales manipulation (Ge & Kim, 2014;Stubben, 2010

Methodology
This study collected data from 2008 to 2018 from CSMAR database. All 1932 listed high-tech enterprises are included, for a total of 7547 samples. Firms whose annual reports include such statements as "certification (along with a specific certification number)" and "subject to 15% income tax" are recognized as high-tech enterprises. These listed high-tech enterprises in China are classified as being in the following sectors: electronics and telecommunications, biotechnology and pharmaceuticals, aircraft and spacecraft, materials, technology services, energy, resources and environmental protection, and advanced technology. R & D expenses are calculated from financial statements; if these numbers are not presented in financial reports, R & D expenditure is capitalized plus R & D expenditure belonging to general and administrative expenses such as R & D expenses or technological development expense minus development expenditure are expensed. Variables and research model of this research are as follows:

Sales Manipulation
To investigate firms engaging in sales manipulation, it is sufficient to measure abnormal levels of operating cash flows (Tabassum et al., 2015). To measure abnormal CFO level, the following model proposed by Dechow et al. (1998) is used. We estimate a version of the sales manipulation model as follow as . .
is the change in sales for year t; Abnormal levels of operating cash flows ( it ε ) are calculated as the difference between reported and expected operating cash flows, wherein the latter are estimated to use the coefficients from model (1). However, this model only reflects the proportion of it ε to assets in year t − 1; therefore, we use it ε times assets in year t − 1 to measure discretionary items correctly. In addition, if .
i t ε form model (1) is positive indicating that enterprises have adopted abnormal levels of operating cash flows to earnings management to increase their adjusted income (i.e., increased sales) ; negative indicating that enterprises have adopted abnormal levels of operating cash flows to earnings management to decrease their adjusted income (i.e., decreased sales);

Earnings Thresholds
We use it ε to measure earnings management. However, this model only reflects the proportion of it ε to assets in year t − 1; thus, we use it ε times assets in year t − 1 to measure discretionary items correctly. Therefore, pre-managed R & D expenses can be expressed as the R & D expenses for year t minus discretionary R & D for year t; pre-managed sales can be expressed as the sales for year t minus discretionary sales for year t.
A firm in China seeking to be recognized as a high-tech enterprise should meet the related requirements. Managers in listed firms in China may manipulate earnings through sales, R & D expenses, or both to satisfy these criteria and obtain the tax benefits. Thus, we define "earnings thresholds" as follow: 1) the proportion of pre-managed R & D expenses to managed sales is 6%, 4%, or 3% in the prior 3 years for firms with different sales amounts in the current year and which managed earnings only through sales, 2) The proportion of managed R & D expense to pre-managed sales is 6%, 4%, 3% in the prior 3 years for firms with different sales amounts in the current year and which managed earnings only through R & D expense, and 3) the proportion of managed R & D expenses to managed sales is 6%, 4%, or 3% in the prior 3 years for firms with different sales amount in the current year and which managed earnings through both sales and R & D expenses.

Model
We examined the frequency distribution of earnings by using the approach of Burgstahler and Dichev (1997). In this case, if "managed earnings" such as proportion of pre-managed R & D expenses to managed sales, the proportion of managed R & D expenses to pre-managed sales, the proportion of managed R & D expenses to managed sales is above 6%, 4%, or 3% in the prior 3 years among firms with different sales amounts in the current year, namely managed earnings as been exceeding earnings thresholds.

Robustness Test
In China, high-tech enterprises must meet the standards for certification as a high-tech enterprise as established in 2008 by the Ministry of Science and Technology, the Ministry of Finance, and the State Administration of Taxation. The core idea is that high-tech firms whether have adjusted their R & D intensity above the certain percent threshold to qualify for high-tech status since the 2008 reform. These enterprises may have had different accounting strategies before and after 2008. We used data from before 2008 1 to determine how much these enterprises focused on R & D activities or innovation and to examine whether   Table 1 showed that the descriptive statistics of sales and R & D expenses model and the estimated cross-section of the discretionary of sales and R & D expenses (all of it ε is measured by Equation (1) to Equation (2) have been passed T-test), the mean of discretionary sales and discretionary R & D expenses are negative, indicating that high-tech enterprises in china have adopted discretionary sales to earnings management to decrease their adjusted income, however adopted discretionary R & D expenses to earnings management to increase their adjusted income. Overall, discretionary sales of Dechow et al. (1998)

Empirical Test
We construct empirical histograms as suggested in Degeorge et al. (1999). According to security law, a firm would like to be listed in china stock market should accumulate above 300 million sales prior 3 years in listed. We can't search out sales below 50 million in the current year of the listed firms in china high-tech enterprises, it is likely that these firms have been listed in stock market, therefore they have bigger size. Additionally, we search out sales from 50 million to 200 million in the current year for 281 samples, however, these firms' pre-managed R & D expenses to pre-managed sales above 4% in the prior 3 years. This is illustrated in Figure 1, which indicates a standardization difference between the negative value to the left of zero and the positive value to the right of zero, and this result is consistent with that of El-Sayed Ebaid (2012). Overall, H1, is not supported when sales from 50 million to 200 million in the current year. It is likely that these high-tech enterprises will not manipulate sales or R & D expenses to accordance with related requirements of the recognition "high-tech enterprise", to obtain tax benefits. They invested consistently in R & D, even when the standards for the certification of high-tech enterprises had not been established. Figures 2-4 focus on the scenarios when the sales are above 200 million yuan in the current year. This is illustrated in Figure 2 to Figure 4 which indicate a standardization difference between the negative value to the left of zero and the positive value to the right of zero, and this result is consistent with that of El-Sayed Ebaid (2012). Figure 2 showed that pre-managed R & D expenses to pre-managed sales above 3% in the prior 3 years (i.e., pre-managed earnings to the right and are higher than earnings thresholds). Thus, H1 is also not supported. It is likely that these high-tech enterprises will still not manipulate sales or R & D expenses to accordance with related requirements of the recognition "high-tech enterprise", to obtain tax benefits (6423 samples). However, for a portion of the samples Source: My primary data source is the CSMAR databases where we calculate yearly observations.  Source: My primary data source is the CSMAR databases where we calculate yearly observations.  (843 samples), pre-managed R & D expenses totaled < 3% of pre-managed sales in the prior 3 years (i.e., pre-managed earnings to the left are lower than earnings thresholds), as shown in Figure 2. Furthermore, Figure 3 shows that pre-managed R & D expenses totaled > 3% of managed sales (through manipulation of sales data) in the prior 3 years (managed earnings to the right are higher than earnings thresholds). Figure 4 shows that managed R & D expenses totaled > 3% of pre-managed sales in the prior 3 years (through manipulation of R & D expense data; managed earnings to the right are higher than earnings thresholds). Figure   5 shows that the proportion of managed R & D expenses was >3% in the prior 3 years (through manipulation of both R & D and sales data; managed earnings to the right are higher than earnings thresholds). Therefore, most of these high-tech enterprises (843 samples) still focus on tax incentives and tend to manipulate earnings through R & D expenses or sales data to meet the related requirements to be recognized as high-tech enterprises (i.e., pre-managed R & D expenses to managed sales, managed R & D expenses to pre-managed sales, or managed R & D expenses to managed sales above 3%). Finally, for a few of the samples, all of these ratios remained below 3%; thus, the degree of manipulation was limited, as can be seen in

Robustness Test
We repeat the same analyses out of sample to tackle a possible sample specific issue and get general robust results. According to the robustness test, we used these enterprises' data from before 2008, and these sample enterprises only

thresholds). Even manipulating R & D expenses or R & D expenses and sales
reports, most of these enterprises still fail to meet the requirements for being recognized as high-tech enterprises. In accordance with the earnings thresholds determined before 2008, these enterprises probably will not manipulate sales or R & D expense reports. Overall, comparing these enterprises before and after 2008 revealed that this policy (i.e., requirements for being recognized as a high-tech enterprise to obtain tax benefits) caused differences in earnings management behavior, which has played an important role in encouraging enterprises to invest in R & D or innovation activities, especially since 2008.

Conclusion
Tax deductions associated with high-tech enterprise certification can encourage investment in R & D or innovation. This rule includes the proportion of R & D expenses to sales above a certain percentage in the prior 3 years among different sales in the current year. This ratio is likely a desired reference point for manipulating sales or R & D expenses to qualify as a high-tech enterprise and obtain tax incentives. This study collected data from 2008 to 2018 from the CSMAR database. All 1932 listed high-tech enterprises were included, for a total of 7547 samples. The results indicate that firms have sales of 50 -200 million yuan in the current year and have accordance with 4% in the prior 3 years before manipulating sales or R & D expenses (281 samples); most of the firms with sales above 200 million yuan in the current year had accordance with 3% in the prior 3 years before manipulating sales or R & D expenses (6423 samples). The results also suggested that 88.83% of the listed high-tech enterprises in China were focused on R & D activities or innovations regardless of whether they qualified as a "high-tech enterprise" according to the China government, suggesting that these enterprises prioritize other financial incentives instead of tax incentives.
However, some samples' (843 samples) proportion of R & D expenses to sales was below 3% in the prior 3 years when sales were above 200 million yuan in the current year before manipulating sales or R & D expenses, and half of them exhibited a proportion of R & D expenses to sales above 3% after manipulating sales or R & D expenses. This indicated that tax deductions associated with high-tech enterprise certification incentivized high-tech firms to invest in R & D or innovation. Furthermore, prospect theory is be supported, because these managers of listed high-tech enterprises seek to maximize economic benefits (i.e., obtain tax benefits) and make decisions by focusing on a certain reference point such as maintaining the proportion of R & D expenses to sales above 3% in the prior 3 years when sales are above 200 million yuan in the current year.
The results provide critical implications for regulators and researchers. Some

Conflicts of Interest
The author declares no conflicts of interest regarding the publication of this paper. . i t SALES is the sales for year t; . i t SALES ∆ is the change in sales for year t; *p < 0.1, **p < 0.05, ***p < 0.01. is the sales for year t − 1; *p < 0.1, **p < 0.05, ***p < 0.01.