The Effect of Changes in Income Shifting on Affiliate Managers’ Internal Reporting Decisions

Posted: 5 May 2022

See all articles by Kenneth J. Klassen

Kenneth J. Klassen

University of Waterloo - School of Accounting and Finance

Cinthia Valle Ruiz

Catholic University of Lille - IESEG School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: April 4, 2022

Abstract

This study examines the interplay between tax and internal reporting incentives among affiliates of multinational corporations (MNCs). MNCs face limited information flows that may prevent affiliates’ performance metrics to be immediately responsive to changes in the firm’s tax planning. Using granular data of affiliates belonging to MNCs from 21 European countries, our study provides new empirical evidence of affiliate internal reporting responses induced by changing tax plans. When high-tax-rate countries tighten income shifting rules, we first document that income shifting is reduced and low-tax-rate affiliates have less income. Second, we predict and document that managers of these low-tax-rate affiliates offset this decrease in profits by managing upwards a key performance metric: affiliate earnings. Our results are consistent with firms not quickly adjusting the affiliate managers’ incentives in the face of changing tax planning strategies, and affiliates managing reported earnings to offset the effect of changes in the tax planning of the firm. Cross-sectional analyses provide further evidence consistent with the theory underlying the main tests. The results support the policy of tightening income shifting rules when the objective is to reduce income shifting, and firms’ central management would benefit from considering the implications of changing tax plans on the assessment of local managers.

Keywords: multinational corporations, tax-motivated income shifting, internal reporting practices, managerial targets

Suggested Citation

Klassen, Kenneth and Valle Ruiz, Cinthia, The Effect of Changes in Income Shifting on Affiliate Managers’ Internal Reporting Decisions (April 4, 2022). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4087676

Kenneth Klassen (Contact Author)

University of Waterloo - School of Accounting and Finance ( email )

Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x38550 (Phone)
519-888-7562 (Fax)

Cinthia Valle Ruiz

Catholic University of Lille - IESEG School of Management ( email )

Socle de la Grande Arche
1 Parvis de la Defense
Puteaux, Paris 92800
France

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