This paper looks at the difference in disclosure requirements between the foreign earnings that companies plan to repatriate back to the United States and those that companies plan to permanently reinvest abroad. The concepts of transparency and compliance are addressed as issues related to the current disclosure requirements surrounding permanently reinvested earnings and the associated unrecognized deferred tax liability. The resulting implications on investors as well as the effects of tax holidays will also be discussed. Overall, this paper aims to prove the need for modification of the current disclosure requirements regarding foreign earnings labeled as permanently reinvested earnings as well as stricter regulation of these requirements in order to increase company compliance.

In recent years, the impact of the permanently reinvested earnings (PRE) assertion on the financial reporting environment has grown tremendously. Under Accounting Standards Codification (ASC) 740, a firm making the PRE assertion is able to avoid recognizing residual U.S. taxes on earnings of its foreign subsidiaries so long as it reinvests those earnings outside of the U.S. Suboptimal reinvestment is a potential consequence for PRE-asserting firms due to limited reinvestment opportunities abroad. Suboptimal foreign reinvestment, typically high amounts of reinvestment in financial assets, may be viewed negatively by financial statement users, particularly those users concerned with the default risk of a firm. The disclosure of PRE-related information varies substantially and the actual degree of compliance with this accounting standard has been questioned by the Securities and Exchange Commission (SEC). While firms may believe it is advantageous to obscure their PRE-related activity due to media or political concerns, recent academic literature has highlighted a negative relation between disclosure quality in financial statements and credit risk. The purpose of this study is to examine the relations among foreign reinvestment strategy, PRE disclosure, and long-term credit ratings. First, I examine the direct effect of a firm's reinvestment strategy on its long-term credit rating. Second, I investigate the relation between a firm's reinvestment strategy and its choice to disclose PRE-related information. Third, I study the relation between a firm's choice to disclose PRE-related information and its long-term credit rating. Finally, I examine the potential attenuating effect of the PRE disclosure on the negative relation between financial reinvestment and credit ratings. Using hand collected PRE data for Fortune 500 firms from 1997-2010, I find a negative relation between the intensity of a firm's reinvestment in financial assets and its (1) long-term credit rating and (2) choice to disclose PRE-related information. Furthermore, I find a positive relation between a firm's choice to disclose PRE and its credit rating. / Ph. D. / In recent years, U.S. multinational companies (MNCs) have been criticized by politicians and media members for using accounting and tax rules to avoid recognizing and paying substantial amounts of tax. Under U.S. accounting rules, U.S. MNCs include the earnings of both domestic and foreign subsidiaries in their net income for financial statement reporting purposes. Furthermore, companies are required to recognize income tax expense on the earnings from both domestic and foreign subsidiaries; this income tax expense recognition lowers companies’ net income. However, companies may make the permanently reinvested earnings (PRE) assertion, allowing them to avoid recognizing income tax expense on the income earned from foreign subsidiaries so long as they reinvest those earnings outside the U.S. Therefore, companies making the PRE assertion capture the income earned from foreign subsidiaries without the penalty of recognizing income tax expense. In order to make the PRE assertion, companies must (1) have a foreign reinvestment plan or strategy and (2) disclose required PRErelated information in the footnotes to their financial statements. One consequence of making the PRE assertion is suboptimal foreign reinvestment in financial assets (cash hoarding, financial investments with low returns, etc.). This may be viewed negatively by financial statement users, particularly those users concerned with the credit risk of a company. I investigate the relations among the effects of making the PRE assertion, (1) company reinvestment strategy and (2) financial statement disclosure quality, and the perception of a company’s credit risk. First, I find that companies more heavily reinvested in financial assets than operating assets (buildings, equipment, etc.) are (1) viewed negatively by credit rating analysts and (2) less likely to disclose PRE-related information. Second, I find that companies disclosing PRE-related information are viewed more favorably by credit rating analysts. Collectively, the results of this study indicate that (1) a company’s reinvestment strategy and its PRE disclosure quality are viewed as risk relevant by credit rating analysts and (2) a company with a reinvestment strategy focused on financial assets is less likely to disclose PRE-related information.