The impact of using tax havens on classification shifting: evidence from public and private UK firms

PurposeThis paper empirically examines how tax haven use affects classification shifting by public and private UK firms.Design/methodology/approachThe authors conduct multivariate regression analyses of classification shifting on proxies of tax haven use for a broad sample of UK non-financial public and private firms from 2010 to 2018. An array of additional tests is conducted to ensure the robustness of the findings.FindingsFirms using tax havens engage in more classification shifting relative to those that do not. The result is concentrated for public firms. While private firms' classification shifting is generally pronounced, it appears unaffected by tax haven use. The findings suggest that the use of tax havens facilitates public firms' classification shifting due to the lower institutional environment quality of these jurisdictions. In addition, classification shifting may be a less costly earnings management device for public firms using tax havens due to their political sensitivity.Practical implicationsThe study highlights the need for regulatory intervention to constrain classification shifting, especially when firms use tax havens. It also calls for further scrutiny by auditors and financial analysts on the classification of income statement items.Originality/valueWhile prior research focuses on accrual and real earnings management by public firms, this study investigates the consequences of using tax havens on classification shifting, a largely underexplored but heavily exploited earnings management strategy. Differences between public and private firms are also tested. Overall, this study offers an advanced understanding of how a firm's institutional and political environments influence its financial reporting.