The Dark Side of Transparency in Developing Countries: The Link between Financial Reporting Practices and Corruption

Abstract

This paper examines the impact of financial reporting practices in over 70,000 firms across 121 countries. While prior studies examining financial reporting practices mainly focus on the benefits of disclosure in developed markets such as the United States, we focus on the costs associated with increased financial transparency in emerging markets where governance mechanisms are relatively weak. We document a strong positive relation between the production of audited financial statements (AFS) and corruption obstacles faced by the firm. We argue that in corrupt business environment, rent-seeking bureaucrats use the available information to optimize their bribe extractions. We further show that country-level institutional quality has an important impact on the cost of transparency: the level of corruption obstacles associated with AFS is significantly higher in countries with weak corruption control mechanism. Our study sheds light on the dark side of transparency: exposure to corrupt bureaucrats where institutions are weak.