Influence of Institutional Relationship between Financial Reporting and Taxation on Corporate Governance in Japan

This paper describes the framework of the institutional relationship between financial reporting and taxation in Japan and discusses how the relationship contributes corporate governance from viewpoints of reduction of some kinds of costs concerning tax compliance and political processes and both honest financial reporting and tax filing, in Japan. It has been criticized that the connection between financial reporting and taxation in Japan often gives rise to interactions between them and distorts relevant financial information because of their different objectives. Furthermore, the connection also might be an obstacle to the international convergence of accounting standards because tax rules in each country reflect different economic policies. The divergence between them is expanding these days due to both changes of accounting standards and tax rules in Japan. There are, however, still some advantages in the connection system. They include the saving of tax compliance costs and political costs. In addition, the trade-off between financial reporting costs and tax costs under the connection system might deter firms from earnings management in both financial reporting and taxation. The purposes of this paper are to point out the costs reduced under the connection system and to identify the conditions under which the trade-off between reporting costs and tax costs is in effective to restrain earnings managements.