Talk softly but carry a big stick: transfer pricing penalties and the market valuation of Japanese multinationals in the
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Talk softly but carry a big stick: transfer pricing penalties and the market valuation of Japanese multinationals in the United States Lorraine Eden1, Luis F Juarez Valdez2 and Dan Li1 1 Department of Management, Texas A&M University, College Station, TX, USA; 2 Department of Accounting and Finance, Universidad de las Americas-Puebla, Cholula, Mexico
Correspondence: Professor L Eden, Department of Management, Texas A&M University, 4221 TAMU, College Station, TX 77843-4221, USA. Tel: þ 1 979 862 4053; Fax: þ 1 979 845 9641; E-mail: [email protected]
Abstract Corporate income tax law in OECD countries requires multinational enterprises (MNEs) to set their transfer prices according to the arm’s length standard. In 1990 the United States (US) government introduced a transfer pricing penalty for cases where MNEs deviated substantially from this standard. More than two dozen other governments have followed suit. Our paper uses event study methodology to assess the impact of the US transfer pricing penalty on the stock market valuation of Japanese MNEs with US subsidiaries in the 1990s. We find that the penalty caused a drop in their cumulative market value of $56.1 billion, representing 12.6% of their 1997 market value. Journal of International Business Studies (2005) 36, 398–414. doi:10.1057/palgrave.jibs.8400141 Keywords: transfer pricing; tax penalty; event study; market value; ADR; Japanese multinationals; IRS
Introduction Nobody wants to pay taxes. No wonder, then, that so many companies spend so much effort trying to avoid them. Almost every big corporate scandal of recent years, from Enron to Parmalat, has involved tax-dodging in one form or another. (The Economist, 2004, 71)
Received: 12 February 2004 Revised: 1 September 2004 Accepted: 4 October 2004 Online publication date: 19 May 2005
Corporate income tax law in all OECD countries requires multinational enterprises (MNEs) to set their transfer prices according to the arm’s length standard; that is, the external market or arm’s length price that two unrelated firms would set for the same or similar product traded under the same or similar circumstances, as the product traded within the MNE (Eden, 1998, 2001). In 1990, the United States (US) government introduced a transfer pricing penalty – Internal Revenue Code y6662 – for cases where MNEs engage in transfer price manipulation (TPM), setting a transfer price that deviates significantly from the arm’s length price. The US Congress approved the y6662 penalty partly in response to the widespread perception that foreign-owned, particularly Japanese, MNEs were paying little US tax (Inoue, 1990). When first introduced, the penalty was broadly condemned by other OECD tax authorities, but over the past few years the policy has begun to spread. Ernst & Young (2004), for example, document the international tax policies of 46 countries in 2003; 27 of the
Talk softly but carry a big stick
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