A new study suggests that expanded financial auditing reporting is having a significant impact on the behavior of multinational corporations in Europe. Specifically, the study finds that requiring more detailed analysis in financial audits appears to be curbing the corporate practice of shifting money internationally in order to pay less in taxes. The study involved data covering more than 8,000 companies across 25 European nations.
Over the past 20 years, national audit boards around the world introduced new standards requiring financial statement auditors to issue expanded audit reports that include “key audit matters” (KAMs). These KAMs essentially detail topics or aspects of a company’s operations that were important, complex or challenging to address when auditing the company’s financial statements for the relevant time period.
“When KAMs were first introduced, researchers reported that they had little impact on how audits were conducted and had little impact on the utility of the KAMs for investors,” says Nathan Goldman, co-author of a paper on the work and a professor of accounting in North Carolina State University’s Poole College of Management. “We wanted to take a different approach and look closely at one specific KAM that relates to uncertain tax positions (UTPs).”
UTPs refer to the fact that companies have to maintain a tax reserve for a specific period of time in case they are audited and may need to pay more in taxes than they anticipated.
“We focused on KAMs related to UTPs involving multinational corporations that move money among their holdings in order to achieve the most advantageous tax position,” says Goldman. “Broadly, we wanted to know if expanded audit reports were influencing corporate behavior. More specifically, we wanted to know if the fact that auditors would report KAMs related to UTPs was influencing the extent to which companies were moving money internationally to reduce their tax burden.”
For this study, the researchers collected financial, economic and tax data from the financial reporting database Amadeus, the International Monetary Fund’s World Economic Outlook Database, and The Tax Foundation. The researchers focused specifically on data from multinational corporations that were headquartered in Europe, operated in multiple countries, had positive pre-tax income, and that provided publicly-available financial statements. The final sample included 207,792 affiliate-year observations representing 8,389 unique companies and 45,909 unique affiliates from multinational groups in 25 European nations from 2012–2021.
The researchers then used statistical tools to determine how, if at all, corporate behavior was influenced by the introduction of UTP KAMs.
“The fact that different European countries adopted expanded audit reports – which include UTP KAMs – in different years gave us a natural experiment to work with,” says Goldman. “It allowed us to track whether the introduction of those UTP KAMs was actually associated with changes in behavior.”
And UTP KAMs did make a difference.
“Basically, we found that when a multinational corporation’s audit included a UTP KAM, that corporation was substantially less likely to engage in international income shifting,” says Goldman. “In other words, the evidence suggests that companies know engaging in that income shifting increases uncertainty among investors about their corporate tax position – and a KAM highlighting their UTP makes income shifting less attractive.”
“This is interesting, in part, because it suggests that expanded audits have an unintended consequence – at least when it comes to the UTP KAMs. More broadly, our work here suggests that understanding the impact of KAMs may require focusing on the specific areas each KAM relates to, whether that’s revenue, intangible assets, research and development, etc. Trying to look at KAMs as a whole may make it more difficult to figure out what’s actually going on.”
The paper, “Tax-related Key Audit Matters and Changes in Multinational Income Shifting,” is published in the journal The Accounting Review. The paper was co-authored by Christof Beuselinck of the IESEG School of Management in Lille, France; Jochen Pierk of Erasmus University Rotterdam; and Cinthia Valle Ruiz of IE Business School at IE University in Madrid, Spain.