Financial Transparency to the Rescue: Effects of Public Country‐by‐Country Reporting in the European Union Banking Sector on Tax Avoidance*

Abstract

ABSTRACTWe analyze the effect of mandatory financial transparency on corporate tax avoidance. The effectiveness of comprehensive tax transparency, in the form of a public country‐by‐country reporting, to mitigate corporate tax planning is largely unknown. Capital Requirements Directive IV by the European Commission required multinational banks to publish key financial and tax data in the form of public country‐by‐country reporting. We examine tax avoidance of banks around the reform. Our focus is on multinational banks newly required to report activities in tax havens that had not been publicly disclosed before the country‐by‐country reporting mandate. We predict and find that these exposed banks increased their tax expense relative to multinational banks with no activities in tax havens to disclose, as well as relative to domestic banks unaffected by the new mandate. In additional tests, we compare our sample of exposed multinational banks to several control groups from the financial sector and other industries. Our results suggest that country‐by‐country reporting can serve as an additional policy instrument to curb corporate tax avoidance, but only when the reporting exposes the firms' tax sheltering activities to public scrutiny.