How Does Transfer Pricing Risk Affect Premia in Cross-Border Mergers and Acquisitions?

Abstract

This study investigates how transfer pricing risk affects the premia in cross-border mergers and acquisitions. Differences in the rigor of transfer pricing enforcement and the severity and clarity of rules across countries create risk of material costs for multinationals as they expand globally. We use 448 country-level transfer pricing risk assessments by global transfer pricing partners and managers from two Big Four accounting firms in 33 countries to develop a metric of country-year transfer pricing risks. The resulting measure of transfer pricing risk is used to analyze the premia of 4,308 cross-border mergers and acquisitions from 1993-2012. Our results suggest that acquirers offer lower premia on their bid when there is increased transfer pricing risk associated with the future operations of the target, consistent with the views of experts in the field. This relation is stronger in target industries with high levels of intellectual property, because targets face greater transfer pricing uncertainty when implementing an arm’s length price. Our results provide the first archival evidence that acquirers consider the risk of uncertain tax costs on future operations when estimating the value of a target to the firm.