Multinationals' income shifting decisions, taxes and intra-company transfers: empirically testing market valuation

This paper tests whether intra-company transfers, viewed as distinct from ordinary sales transactions by policy makers and tax regulators, are associated with share price. When a multinational firm (MNC) transfers its intermediate goods between the parent company and its foreign subsidiary, its discretion over the price of goods can result in shifting income from a high tax to a low tax regime, reducing its overall tax liabilities. Intuitively, these tax savings represent an incremental value to the firm's shareholders. Thus, employing a variant of Ohlson's (1995) equity-valuation model, we test and document that firms that engage in intra-company transfers are rewarded with higher equity value. This is consistent with intra-company transaction choices significantly influencing firm value and opportunistic transfer pricing having market benefits. We also examine whether international transfers are connected to foreign pretax profit margins and foreign tax costs. Consistent with prior works (Klassen et al., 1993; Pak and Zdanowicz, 1994; Gramlich and Wheeler, 2003), we document that foreign pretax income and tax costs are positively related to intra-firm transfers, indicating that US multinationals shifted income away from the USA from 1998 to 2002.