DOES PRIVATE COUNTRY-BY-COUNTRY REPORTING IMPROVE THE TAX AND EARNINGS INFORMATION ENVIRONMENT FOR INVESTORS?

Abstract

To better align rights to tax with underlying economic activities, many countries require multinational enterprises (MNEs) to disclose their income and economic activities to tax authorities on a country-by-country reporting (CbCR) basis. We examine whether this significant international tax transparency policy shock generates positive information externalities for the capital markets. We develop a novel approach to capture the misalignment between MNE's tax and economic activities, as perceived by the capital market, using the unexplained portion of analysts' tax forecasts error. We find that this misalignment declines after the adoptions of CbCR, supporting the effectiveness of its policy objective. We then examine the tax and earnings information environment using analysts' forecast accuracy and the information content of tax and earnings to investors. We find that CbCR helps improve both tax and earnings information environment, especially when firms have more misalignment prior to the policy change. Our findings have important policy implications for governments worldwide that are trying to assess the economic consequences of CbCR.