The Valuation of Economic Earnings and Income Shifting of U.S. Multinationals in Domestic and Foreign Jurisdictions

Abstract

I study U.S. multinationals' economic earnings and income shifting across their domestic and foreign jurisdictions. This study develops the concept of economic earnings, measures economic and shifted earnings, tests their market valuation, and tests differences in valuation across investor types. I conceptualize economic earnings by distinguishing between domestic and foreign earnings reported by firms and earnings created in these jurisdictions. I then measure domestic and foreign economic earnings by estimating country-specific (i) locations and (ii) economic earnings for U.S. multinationals. I estimate country-level economic earnings using a productivity function of domestic-only firms in each country. I test the validity of the economic earnings estimation procedure using a sample of domestic-only firms across 81 countries. The income shifting measure is the difference between reported and economic earnings. I theoretically and empirically compare the income shifting measures created in this study to existing measures and test their association with tax avoidance. For the valuation tests, I develop two earnings decomposition models that decompose total earnings into (a) domestic and foreign economic earnings and (b) shifted and resident components of earnings. I find that domestic and foreign economic earnings are value-relevant and valued relatively differently than domestic and foreign reported earnings. I fail to find evidence that income shifted into and out of the U.S. are value-relevant. I find that more sophisticated investors are associated with the valuation of income shifting and find, contrary to my predictions, that less sophisticated investors recognize underlying economic earnings components.