Talk Softly but Carry a Big Stick: Transfer Pricing Penalties and the Marekt Valuation of Japanese Multinationals in the United States

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 US government introduced a transfer pricing penalty for cases where MNEs deviated substantially from this standard. Most OECD governments have followed with their own penalty legislation. This paper investigates the theoretical and empirical effects of transfer pricing penalties on the behavior and profits of multinationals. Event study methodology is used to analyze the effects of the US penalty legislation on the stock market valuation of Japanese MNEs with US subsidiaries. We find that even the threat of the penalty negatively affected market valuation.

Number of Pages in PDF File: 34

Keywords: Transfer pricing, tax penalty, tax avoidance, market valuation, corporate income tax, intrafirm trade, Japanese multinationals, Internal Revenue Service

JEL Classification: E62, F21, F23, H25, H26, K34, L62

Accepted Paper Series