Democracy, Institutions, and International Profit-Shifting

Does constitutional democratization affect profit-shifting strategies among firms? Using a global sample of multinational enterprises, we develop a subsidiary-year measure of profit-shifting and examine how this measure responds to changes in constitutional democracy and the subsequent evolution of the host country’s institutions. Our main findings show that a one-standard-deviation increase in the Polity IV democracy index yields an approximately 37% decrease in profit-shifting to other countries. Protection of property rights, contract enforcement, and superior regulatory quality emerge as the key institutional channels that define the decision to keep profits at home. Our results are robust to an instrumental variables approach and a large battery of additional robustness tests.