Country-by-Country Disclosures and Firms' Internal Information Environment

Abstract

We examine the relationship between country-by-country disclosures and multinational entities’ internal information environments. We argue that the introduction of U.S. country-by-country reporting (CbCR) induces firms to change their information processing structures when the demanded information is not readily available, thereby increasing the need for effective information flows but simultaneously adding reporting complexity. We use a difference-in-differences design to examine our hypothesis and find that firms affected by CbCR have a significantly lower likelihood of having tax-related material weaknesses in internal controls than other firms. The effect is robust to alternative research designs, placebo tests, sample balancing, and addressing the rarity of internal control weaknesses. Consistent with less complex firms benefitting more from CbCR disclosure rules, we find the results to be pronounced in firms with lower ex ante organizational complexity. Finally, we show that firms with material weaknesses become less likely to address issues with a cross-border context in the 10-K filing when affected by CbCR. Our results are consistent with CbCR stimulating firms to improve their information processing structures, resulting in higher-quality internal controls.

Keywords: BEPS, country-by-country disclosure, internal control system, internal information environment, tax transparency, regulation

JEL Classification: G38, H25, H26, M41, M42, M48