Intra‐firm organization and profitability

Purpose - By conducting a field research in affiliates of foreign transnational corporations (TNCs) established in Greece, this paper aims to investigate whether a different tendency of intra‐firm organization has a different impact on their profitability and earnings management policy. Design/methodology/approach - The original sample consists of 82 affiliates of foreign TNCs. Using a cut off point (25 percent) indicative of intra‐firm pattern, these affiliates are divided into two categories: foreign subsidiaries with a high intra‐firm trade degree (or with intra‐firm trade >25 percent of their total trade) and foreign subsidiaries with a low intra‐firm trade degree (or with intra‐firm trade ≤25 percent of their total trade) correspondingly. The paper utilizes two econometric tests over the period 1999‐2002: first, a logit model is employed to identify possible accounting‐based performance differences related to differential degrees of intra‐firm trade. Second, the popular cross‐sectional discretionary accruals model initiated by Jones is applied in order to detect differences concerning earnings management policy between the two groups of affiliates. Based on the internalization theory of TNC, the main hypothesis is that the foreign affiliates with high intra‐firm trade degree are more likely to affect their profitability, and due to institutional specific characteristics of Greece (e.g. relatively high tax rates), they appear to have smaller profits in comparison to the other subsidiaries. Findings - Contrary to initial predictions, the impact of intra‐firm trade on the profitability of foreign affiliates did not prove statistically significant. Results concerning the earnings management policy are similar. TNCs in general are found not to manipulate their reported earnings figure more than a neutral sample of 847 domestic companies. Research limitations/implications - The list of explanatory variables is not an exhaustive one. In further quantitative work, more complex econometric methods should be used to support findings. Practical implications - Findings are of particular interest for a multiple set of stakeholders/investors active in global markets as well as for regulators in attempting to ensure the coordination of tax policies among countries. Specifically, it is important for stakeholders and investors to know to what degree the integration of the subsidiary units (they have invested in) affects their performance and differentiates the manner that profits are managed. In addition, the regulators seek to define in detail the factors that make up profits on the inside of multinational enterprises so that they can practice their policies more effectively. Moreover, the findings may be applicable to other smaller countries which resemble the Greek setting. Originality/value - The paper presents two novelties. First, it discloses original information regarding the internalization of trade activities of foreign affiliates located in Greece; such information is quite rarely found in literature. Second, it is one of the first studies which combines income policy of TNCs to their intra‐firm transactions.