Cross-Jurisdictional Income Shifting and Earnings Valuation

Abstract

This research investigates the extent to which U.S. multinational enterprises (MNEs) engage in tax-motivated income shifting between the U.S. and foreign jurisdictions and whether investors differentially capitalize shifted income, based on its true source or its reported source. We find evidence that U.S. MNEs facing foreign tax rates that on average exceed the U.S. statutory tax rate shift taxable income into the United States, and that investors recognize firms' income-shifting patterns when valuing the foreign versus domestic components of reported earnings. We examine U.S. multinational manufacturing companies from 1984 to 1992 to determine the cross-sectional relation between firm-level foreign profit margins and average foreign tax rates. If U.S. MNEs respond to high (low) foreign tax rates by shifting income into (out of) the United States, then ceteris paribus we expect a negative relation between foreign profit margins and average foreign tax rates. In addition,