Incentivizing High-Tech Firms to Establish Foreign Retail Subsidiaries: The Role of Network Effect
Posted: 24 Oct 2019 Last revised: 23 Oct 2023
Date Written: October 20, 2023
Abstract
Network effect significantly influences the market expansion of high-tech firms due to pronounced herd behaviors exhibited by customers in this industry. Numerous firms have strategically harnessed this effect to enhance customer purchasing behaviors by establishing retail subsidiaries in foreign markets. This study investigates the impact of network effect on the global product selling strategies (channel structures) of a multinational high-tech firm in a generalized taxation setting, where the foreign tax rate may be lower or higher than the domestic tax rate of the high-tech firm. Our analysis reveals intriguing findings that highlight the intricate interplay between the degree of tax disparity and network effect. Specifically, a strong network effect incentivizes the high-tech firm to lower the transfer price and introduce foreign retail subsidiaries. The varying foreign tax rates lead the high-tech firm to employ different tax-planning mechanisms to retain substantial profits either in the foreign or domestic tax jurisdiction. This results in the high-tech firm’s preference for establishing a retail subsidiary, even when the foreign tax rate surpasses the domestic tax rate. We further explore how the high-tech firm’s incentives may evolve with the introduction of two major tax reforms: tax deferral termination and the reduction of corporate income tax rate in the U.S. Tax Cuts and Jobs Act.
Keywords: Network effect, Tax disparity, MNF’s global market entry, Competitive encroachment, Game theory
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