TESTING

TAXATION & FIRM PERFORMANCE

Normative theories attempt to tell what “people or constituencies should do”. A normative theory is not solely evaluated by predictive value, but is also evaluated by its logical consistency of how rational individuals should behave. Positive theories “attempt to make good predictions of real world events.”
Positive Accounting Theory (PAT) is a positive theory that aims to predict actions such as which accounting policies firms will choose and how newly proposed accounting standards will cause firms to react. Its overall intention is to understand and predict the choice of accounting policies across differing firms. It recognizes that economic consequences exist.
Under PAT, firms want to maximize their prospects for survival, so they organize themselves efficiently. Actual organization depends on firm specific factors, which are the determinants of their prospects. Examples include legal and institutional environment, technology, and competition. Firms are viewed as the accumulation of the contracts they have entered into.
In relation to PAT, because there is a need to be efficient, the firm will want to minimize costs associated with contracts. Examples of contract costs are negotiation, renegotiation, and monitoring costs. Contract costs involve accounting variables as contracts can be stipulated in terms of accounting information such as net income, and financial ratios. The firm will choose the accounting policies that best acknowledge the need for minimization of contract costs.
A study conducted by Mian and Smith found evidence supporting the predictions that: * The more interdependent a parent and subsidiary are, the more likely the firm will be to create consolidated financials statements. Consolidated financial statements would be more efficient than separate financials and therefore more