Unprofitable Affiliates and Income Shifting Behavior

November 2, 2013 Leave a comment

Unprofitable Affiliates and Income Shifting Behavior

Lisa De Simone Stanford Graduate School of Business

Jeri K. Seidman University of Texas at Austin – McCombs School of Business

October 15, 2013
Rock Center for Corporate Governance at Stanford University Working Paper No. 157

Abstract: 
Income shifting from high-tax jurisdictions to low-tax jurisdictions is commonly considered in the accounting, finance and economics literature as a method to reduce worldwide tax burdens of multinational firms. However, the presence of an unprofitable affiliate provides another potential tax-reducing recipient of shifted income. We develop an income prediction model that does not rely on the logarithm of profitability and thus can be applied to both profitable and unprofitable affiliates. After confirming prior results on a sample of profitable affiliates using our new model, we test whether unprofitable affiliates report lower losses than a matched sample of unprofitable stand-alone firms, and whether these differences in profitability are correlated with tax-related factors. Results are consistent with income shifting to unprofitable affiliates being an important transfer pricing consideration for multinational firms; however, we also find evidence of risk sharing within multinational groups. Overall, results suggest that risk sharing and a shift-to-loss income shifting strategy both influence the unexpected profitability of unprofitable affiliates.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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