CEIS - CENTRE FOR ECONOMICS AND INTERNATIONAL STUDIES

In choosing transparency, firms must trade off the benefits from access to more abundant and cheaper capital against the cost of a greater tax burden. The paper studies this trade-off in a model with distortionary taxes and endogenous rationing of external finance, and tests its predictions using two different data sets with listed and privately-held firms. The predictions of the model are borne out by the evidence from both data sets. First, investment and access to finance are positively correlated with accounting transparency and negatively with tax pressure, controlling for firm-level characteristics, sector and country effects. Second, transparency is negatively correlated with tax pressure, particularly in sectors where firms are less dependent on external finance, and is positively correlated with tax enforcement. Finally, financial development enhances the positive effect of transparency on investment, and encourages transparency by firms that depend more on external finance.

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