Heads I Win, Tails You Lose: Asymmetric Taxes, Risk Taking, and Innovation

Abstract

When multinationals face lower tax rates abroad than in the US, transfer pricing strategies generate an asymmetry in the tax rates on a project's profits and losses. We show that the tax savings from transfer pricing can be expressed as a long position in a call option. We use a model to show that this transfer pricing call option leads a firm to choose riskier and larger projects than it would otherwise. Thus, transfer pricing strategies do not simply reduce a firm's taxes, they can influence the scale and types of projects undertaken.

Keywords: Corporate Risk Taking, Multinational Corporations, Transfer Pricing, Taxation, Profit Shifting, Tax Avoidance, R&D, Intellectual Property, Corporate Investment

JEL Classification: G31, G32, G38, F21, F23, H25, H26, K34, O34, O38