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Beyond Tax Avoidance: Offshore Firms’ Institutional Environment and Financial Reporting Quality

Journal of Business Finance and Accounting 44 (5-6): 646-696

51 Pages Posted: 5 Jan 2010 Last revised: 17 May 2017

Art Durnev

University of Iowa - Henry B. Tippie College of Business

TieMei Li

University of Ottawa - School of Management

Michel Magnan

Concordia University - Department of Accountancy

Date Written: May 17, 2017

Abstract

We explore how firms’ operations in Offshore Financial Centers (OFCs) through
subsidiaries or affiliates affect the quality of financial reporting. Using a unique and large sample of firms that have headquarters in the 15 countries with the strictest legal regimes and have subsidiaries or affiliates in OFCs, we find that such firms exhibit lower financial reporting quality than comparable firms without OFC operations. We also find that as OFC characteristics become more prevalent, firms are more likely to engage in both accrual-based and real earnings management. More importantly, after disentangling OFC characteristics into the opportunity for tax avoidance, regulation arbitrage and secrecy policies, we find that beyond tax avoidance, regulation arbitrage and the secrecy policies of OFCs significantly affect financial reporting quality. The causal effect of OFC operations is supported by the analysis of financial reporting quality when firms set up OFC operations. Our findings are robust to various
additional tests addressing potential endogeneity issues. We conclude that the assessment of a firm’s institutional environment must encompass the registration status of its subsidiaries or affiliates as well as its own.

Keywords: Offshore Financial Centers, financial reporting quality, earnings management

JEL Classification: F36, G15, G34, H26, K22, M41

Suggested Citation

Durnev, Art and Li, TieMei and Magnan, Michel, Beyond Tax Avoidance: Offshore Firms’ Institutional Environment and Financial Reporting Quality (May 17, 2017). Journal of Business Finance and Accounting 44 (5-6): 646-696 . Available at SSRN: https://ssrn.com/abstract=1325895 or http://dx.doi.org/10.2139/ssrn.1325895

Artyom Durnev

University of Iowa - Henry B. Tippie College of Business ( email )

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5020 Main Library
Iowa City, IA 52242-1000
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(514) 398-5394 (Phone)
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HOME PAGE: http://www.artdurnev.com

TieMei Li (Contact Author)

University of Ottawa - School of Management ( email )

136 Jean-Jacques Lussier Street
Ottawa, Ontario K1N 6N5
Canada

Michel Magnan

Concordia University - Department of Accountancy ( email )

Montreal, Quebec H3G 1M8
Canada

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