Review of the deterrent effect of whistleblowing
Whistleblowers not only help expose immoral or criminal acts, but also deter offenders. Niels Johannesen, professor of economics at the University of Copenhagen and Tim Stolper, former research associate at the Max Planck Institute for Tax Law and Public Finance found clear evidence of this chilling effect, using the example of data leaks surrounding banking services in tax havens. . Economists have found that after the first data leak emerged, which came from LGT Bank in Liechtenstein, Swiss banks involved in cross-border tax evasion also suffered significant drops in their share prices. At the same time, bank deposits in tax havens fell by more than 10% compared to deposits in non-haven countries.
Whistleblowers steal confidential information in order to expose criminal actions such as tax evasion. For this, they are sometimes considered “heroes of our time”, to paraphrase Alfred de Zayas, former UN special rapporteur for the promotion of a democratic and equitable international order. This positive view of informants assumes that whistleblowing not only acts as a catalyst for prosecuting individual criminals, but also promotes honest behavior by lifting the veil on unwanted conduct. The empirical results of Niels Johannesen, professor of economics at the University of Copenhagen and Tim Stolper, former associate researcher at the Max Planck Institute for Tax Law and Public Finance, support this hypothesis.
For their analysis, Johannesen and Stolper looked at developments in Switzerland, the world’s largest financial center for cross-border wealth management. Economists have watched how the share prices of Swiss banks involved in offshore tax evasion reacted to a total of 13 data leaks that became public. Their key insights come from analyzes of the so-called Liechtenstein tax case, the first data leak from a bank involved in tax haven activities to come to public attention. An employee of LGT Bank in Liechtenstein had copied customer information and then sold it to the German Federal Intelligence Service. Liechtenstein’s tax CD sparked the scandal around former Deutsche Post chief Klaus Zumwinkel in 2008, and in the following weeks around 800 other suspects were caught in the authorities’ spotlight.
Data leak lowered profit expectations
Johannesen and Stolper’s review found that the share prices of Swiss “tax avoidance banks” behaved quietly in the ten trading days leading up to the LGT leak. However, in the first two days after the revelations, their prices fell by a market-adjusted amount of 1.1%, and in the following four days by a total of 2.2%, which is statistically significant. Banks that helped hide money from financial authorities clearly suffered a significant drop in their earnings expectations following the LGT Bank data leak.
According to the theory of efficient financial markets developed by Nobel laureate in economics Eugene Fama, stock prices always follow available information and reflect the net present value of expected future earnings. They increase when there is new positive information about future earnings and decrease if new negative information emerges. Applying this theory to Johannesen and Stolper’s results, a drop in stock prices at the exact time of the data leak can be interpreted as the financial markets expecting to see a decline in future profits from offshore criminal activity.
Since the Liechtenstein tax case was the first data breach made public, tax evaders and their accomplices – according to the researchers’ interpretation – had so far either not taken into account the risk emanating from the data leaks, or hadn’t done enough. The first perception of the risk of data leakage, or at least the perception of an increased risk, has therefore affected the supply and demand for offshore banking services and reduced the expected profits of offshore service providers.
This idea is supported by the results of further analyzes by Johannesen and Stolper. For example, Swiss banks unrelated to offshore tax evasion suffered no decline in their share price. It can also be assumed that US authorities initially investigated banks where they suspected the greatest involvement in offshore tax evasion or where they had the clearest signs of such activity, and that investors on the stock markets harbored similar suspicions. This is consistent with the finding that stock prices of banks that were subsequently criminally investigated by US authorities fell more significantly (6.1% in four days after the data leak) than those of banks. who subsequently offered voluntary disclosures (1.2% in four days). The two economists also established that banks that had to pay above-average penalties also suffered larger declines in their share prices (3.2% in four days) than banks whose penalties were below the average. median (1.4% in four days).
Bank deposits in tax havens fell worldwide
Johannesen and Stolper also found that the subsequent discovery of offshore banking activity, for example the Swiss Leaks in 2009 or the Panama Papers in 2016, no longer had significant effects on bank stock prices. This result also supports the main hypothesis of the scientists: after the revelation of the first data leak, the owners of illegal bank accounts and offshore companies as well as their accomplices on the side of the banks adjusted their expectations, i.e. say taken into account the risk that their criminal schemes could be uncovered. Stock prices fell because new negative news affected the price. The data leaks that subsequently came to light contained no additional news in terms of the risk of discovery.
Finally, Johannesen and Stolper supported their theory of the chilling effect of whistleblowing with statistics from the Bank for International Settlements. After the data leak, international bank deposits in tax havens around the world fell by more than 10% compared to deposits in countries not acting as tax havens. This implies that the warning effects identified by economists are more than just a financial market phenomenon. On the contrary, the revelations had real consequences, namely the effect of scaring off tax evaders and their accomplices.
The research has been published in The Journal of Law and Economics.
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Niels Johannesen et al, The deterrent effect of whistleblowing, The Journal of Law and Economics (2022). DOI: 10.1086/715197
Provided by the Max Planck Society
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