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Risk as determinant of income and cross-border pricing of multi-national enterprises

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  • Stefan Lutz
  • Daniel Kleinfeldt

Abstract

International taxation rules for multi- national enterprises (MNEs) prescribe that international prices for goods and services between different subsidiaries – and therefore incomes of these subsidiaries - must be comparable to those set between independent international firms for the purpose of taxation. These rules also prescribe that risk should be accounted for in pricing and income. Since current practice of price comparisons does not yet fully allow accounting for risk, prices and in turn earnings and taxation may be distorted. We analyze a panel of about 160,000 European manufacturing, wholesale and retail trade firms for the years 1992 to 2007 in order to establish to what extent earnings do take risk into account. Risk measured by earnings volatility emerges as one major determinant of income. When earnings are set in relation to invested capital, risk emerges as the only stable determinant of income. Results indicate that both MNEs and independent firms regularly account for risk as a major determinant of income when pricing international goods and services.

Suggested Citation

  • Stefan Lutz & Daniel Kleinfeldt, 2010. "Risk as determinant of income and cross-border pricing of multi-national enterprises," ICER Working Papers 19-2010, ICER - International Centre for Economic Research.
  • Handle: RePEc:icr:wpicer:19-2010
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    References listed on IDEAS

    as
    1. Lutz, Stefan, 2013. "Risk premia in multi-national enterprises," The North American Journal of Economics and Finance, Elsevier, vol. 25(C), pages 293-305.
    2. Hausman, Jerry, 2015. "Specification tests in econometrics," Applied Econometrics, Russian Presidential Academy of National Economy and Public Administration (RANEPA), vol. 38(2), pages 112-134.
    3. Fama, Eugene F., 1977. "Risk-adjusted discount rates and capital budgeting under uncertainty," Journal of Financial Economics, Elsevier, vol. 5(1), pages 3-24, August.
    4. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    5. André F. Perold, 2004. "The Capital Asset Pricing Model," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 3-24, Summer.
    6. Stefan Lutz, 2011. "Simultaneous determination of market value and risk premium in the valuation of firms," Economics Discussion Paper Series 1120, Economics, The University of Manchester.
    7. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Lutz, Stefan, 2013. "Risk premia in multi-national enterprises," The North American Journal of Economics and Finance, Elsevier, vol. 25(C), pages 293-305.

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    More about this item

    Keywords

    MNE; transfer pricing; OECD guidelines; risk; income;
    All these keywords.

    JEL classification:

    • F2 - International Economics - - International Factor Movements and International Business
    • K2 - Law and Economics - - Regulation and Business Law
    • L0 - Industrial Organization - - General
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting

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