Accounting Standards, Information Flow and Firm Investment Behavior

We present a description of two different accounting regimes that govern reporting practice in most developed countries. "One-book" countries, e.g. Germany, use their tax books as the basis for financial reporting and "two-book" countries, e.g. the United States, keep the books largely separate. We derive a structural model and formalize a testable implication of our discussion: firms in one-book countries may be reluctant to claim some tax benefits if reductions in taxable income may be misinterpreted by financial market participants as signals of lower profitability. Econometric estimates suggest that accounting regime differences play an important role in describing domestic investment patterns both within and across countries.