Abstract

This study explores the quality of financial reporting, which is measured by earnings management, and the valuation of firms that operate in offshore financial centers (OFCs). First, I investigate whether offshore firms engage in more earnings management than non-offshore firms, and how the use of OFCs facilitates earnings management. Second, through an event study and other valuation methodologies, I analyze the short- and long-run value implications for firms that have transferred to, or set up affiliates or registered in OFCs. On the one hand, from an investor's perspective, an offshore fine can garner tax avoidance or deferral benefits, thus increasing its value. On the other hand, many OFCs have relatively loose legal regimes, flexible regulations, secrecy policies and the tolerant of economic crimes (Masciandaro (2006)). Under these conditions, investors may face increased risks of poor corporate governance and managerial expropriation of resources, which undermine a firm's value. Using a large sample of 10,553 offshore firm-year observations in 21 OFCs from 1998 to 2007, compared to a non-offshore sample with 30,621 firm-year observations in 37 countries and jurisdictions, I find that offshore firms engage in more earnings management than non-offshore firms, with OFCs facilitating both accruals and real earnings management. Moreover, offshore firms are more likely to have higher value than non-offshore firms largely because of their tax benefits. However, the valuation gap between offshore and non-offshore firms has decreased significantly after a series of scandals involving OFCs, such as Enron and Parmalat, which have occurred since 2001, indicating that investors of offshore firms pay more attention to governance mechanisms instead of the tax avoidance benefits. In addition, I document that an increase in offshore characteristics, which are measured by the Offshore Attitude Indexes, translates into offshore firms being more likely engage in accruals management rather than real earnings activities. In contrast, firm value is more likely to decrease. Finally, my analysis provides evidence that the enactment of the Sarbanes-Oxley Act (SOX) has significantly reduced accruals management and firm value of offshore firms that are listed or cross-listed in the U.S. stock markets. This study extends prior research on international financial reporting and firm value into new territory and provides novel insights into the interface between a firm's legal regime, its governance structures and its value and financial reporting quality.