Offshore Financial Centers, Delayed Loss Recognition, and Stock Price Crashes: An International Study

Of late, issues surrounding offshore firms, in particular, the complex and opaque nature of offshore operations, have received much attention from the global investment community, international organizations such as the OECD and the IMF, securities regulators, tax authorities, legislators, and other public policymakers. However, little has been known about the causes and consequences of offshore operations. To this end, the proposed research aims to provides useful insight into important aspects of offshore operations, namely their impacts on the delayed recognition of bad news as losses and stock price crash risk. In so doing, the proposed research focuses on the asymmetric disclosure incentives of offshore firms with respect to bad versus good news, namely offshore firms' incentives to withhold bad news and to accelerate the release of good news. Specifically, we investigates two distinct, but related, questions: Our first objective is to investigate whether and how the asymmetric disclosure incentives lead to the delayed recognition of bad news as a loss and the accelerated recognition of good news as a gain.Our second objective is to examine an important, but not yet explored, aspect of the stock market consequence of offshore operations, namely the impact of offshore operations on stock price crashes. The asymmetric disclosure, in particular, the bad news hoarding, allows offshore firms to accumulate bad news within the firm. However, there is an upper limit to bad news hoarding. When the accumulated amount of hidden bad news crosses this limit, as manifested in the Enron debacle, the firms are forced to release bad news to outside investors all at once, which causes a large and abrupt decline in stock prices, or stock price crashes. Further, the hiding of bad news deters outside investors and the board of directors from discerning bad projects and exercising their abandonment options at an early stage. As a result, the bad outcomes of negative NPV projects accumulate over time, which, anew, increases the likelihood of crash occurrences. One can therefore predict that offshore firms are more prone to experience stock price crashes than non-offshore firms.Given the lack of empirical evidence on the above issues, the proposed research could provide public policy makers, tax authorities and/or securities regulators with potentially useful insights into the dark sides of offshore operations, namely aggressive reporting and high crash risk.