| The purpose of this study is to quantify cross jurisdictional income shifting at the firm level using publicly available information and to examine the equity market's valuation of shifted income relative to domestic and foreign earnings. In general, income shifting is the selective allocation of revenue and expenses within an organization to manage the profits reported by affiliated members. Regardless of the motivations behind income shifting practices, U.S. multinational corporations (MNCs) shifting income to or from affiliates located in foreign jurisdictions report biased earnings components that reflect a blend of true geographic sources. Prior research finds significant differences between the market's valuation of reported domestic and foreign earnings components. Therefore, the magnitude of a firm's cross jurisdictional income shifting will affect its market valuation to the extent investors distinguish between actual and reported sources of earnings.; A profit optimization model is developed to estimate the amounts and directions of shifted income for MNCs reporting financial information in accordance with generally accepted accounting principles (GAAP). The results from applying the model to each of the 326 U.S. MNCs disclosing all necessary data indicate that shifted income represents approximately 14.7% of the total pretax income reported by the firms over a sliding two-year period, which includes fiscal years ending between December 1998 and November 2000. In the aggregate, the firms in this study shifted an estimated {dollar}10.1 billion in pretax income out of the U.S. (net of inbound shifting) during the fiscal periods resulting in an approximate {dollar}3.5 billion loss in contemporaneous U.S. income tax revenues.; The results of this study also provide evidence of the equity market's recognition of the inbound and outbound cross-jurisdictional income shifting of U.S. MNCs. Specifically, for the 246 firms consistently shifting income in the same direction over two consecutive fiscal years, positive abnormal stock returns are significantly associated with increases in shifted earnings components as well as the amounts shifted both from and to affiliates located in relatively high-tax foreign jurisdictions. The later finding suggests the market's assessment of the income shifting practices of U.S. MNCs is not solely driven by tax considerations. |
