Does Country-by-Country Reporting Affect Internal Control Quality?

Münster, Till; Watrin, Christoph

Abstract

We examine whether the U.S. non-public country-by-country reporting (CbCR) mandate affects multinationals’ internal control quality. We argue that CbCR requires firms to change their information processing structures because the demanded information is not readily available, thus encouraging adjustments to internal controls but simultaneously increasing the risk of weakness exposure. We find that firms affected by CbCR have a significantly lower likelihood of having material weaknesses in their internal controls than control firms. The effect is limited to tax-related weaknesses but robust to falsification tests, sample balancing, and addressing the rarity of internal control weaknesses throughout the sample. We also show that our results are not driven by remediations of material weaknesses before the CbCR adoption. Finally, we observe that the response prevails in tax-aggressive firms and firms with low tax accrual quality. Our results are consistent with CbCR stimulating firms to improve their information-processing structures, resulting in better internal controls.

Keywords
tax transparency; country-by-country reporting; internal controls; financial reporting quality