Network Effect and Tax Planning in a Multinational Firm’s Global Entry Decisions

Posted: 24 Oct 2019 Last revised: 23 Aug 2021

See all articles by Baozhuang Niu

Baozhuang Niu

School of Business Administration, South China University of Technology

Zihao Mu

South China University of Technology - School of Business Administration (SBA)

Lei Chen

School of Management, Jinan University

Yong Jin

The Hong Kong Polytechnic University

Hsing Kenneth Cheng

University of Florida - Warrington College of Business

Date Written: October 15, 2019

Abstract

Network effect facilitates a multinational firm’s (MNF’s) entry into a foreign market by effectively expanding the market size. To extract the value of network effect, an MNF could enter a foreign market with channels including an authorized third-party seller (indirect channel) and its own retail subsidiary (direct channel). However, the network effect benefit must be balanced against the additional set-up cost and the MNF’s foreign taxes. This paper studies the impacts of tax planning and network effect on an MNF’s entry strategies in generalized taxation settings, where the foreign tax rate could be either lower or higher than the home country. Several intriguing findings are discovered highlighting the complicated interactions between the degree of tax disparity and network effect. In particular, as a strong network effect incentivizes the MNF to lower the transfer price and introduce a foreign retail subsidiary, tax consideration further changes the MNF’s transfer pricing incentives, and subsequently its preferred entry strategies. We find that the varying foreign tax rates induce the MNF to leverage different tax saving mechanisms to keep large profits in either the foreign or domestic tax jurisdiction, resulting in the MNF’s preference of establishing a retail subsidiary even when the foreign tax rate is higher than the domestic tax rate. We further examine how the MNF’s incentives may change with the introduction of the two major tax reforms in the U.S. Tax Cuts and Jobs Act of 2017, namely the tax deferral termination and the reduction of corporate income tax rate.

Keywords: Network effect, Tax disparity, MNF’s global market entry, Competitive encroachment, Game theory

Suggested Citation

Niu, Baozhuang and Mu, Zihao and Chen, Lei and Jin, Yong and Cheng, Hsing Kenneth, Network Effect and Tax Planning in a Multinational Firm’s Global Entry Decisions (October 15, 2019). Available at SSRN: https://ssrn.com/abstract=3470094

Baozhuang Niu (Contact Author)

School of Business Administration, South China University of Technology ( email )

Wushan
Guangzhou, AR Guangdong 510640
China

Zihao Mu

South China University of Technology - School of Business Administration (SBA) ( email )

Wushan
Guangzhou
China

Lei Chen

School of Management, Jinan University ( email )

Huang Pu Da Dao Xi 601, Tian He District
Guangzhou, Guangdong 510632
China

Yong Jin

The Hong Kong Polytechnic University ( email )

Hong Kong

Hsing Kenneth Cheng

University of Florida - Warrington College of Business ( email )

P.O. Box 117169
Gainesville, FL 32611-7169
United States
352-392-7068 (Phone)
352-392-5438 (Fax)

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