S-Space College of Business Administration/Business School (경영대학/대학원) Dept. of Business Administration (경영학과) Theses (Ph.D. / Sc.D._경영학과)
Essays on Corporate Strategies to Counter the Enforcement of Gift Taxes on the Benefits Tunneled through Abnormal Related-Party Sales
일감몰아주기 증여세 과세 도입에 대응한 기업의 전략
- 경영대학 경영학과
- Issue Date
- 서울대학교 대학원
- related-party sales; tunneling; gift taxes; transaction costs; classification shifting; operating income
- 학위논문 (박사)-- 서울대학교 대학원 : 경영학과, 2016. 8. 정운오.
- In this dissertation, which comprises of two related but independent essays, I examine how firms engage in strategies to counter the enforcement of gift taxes on the benefits tunneled through abnormal related-party sales (RPS). Prior studies document that related-party transactions (RPT) are a viable tool of transferring the wealth within a business group into the ultimate shareholders (Chang and Hong 2000
Liu et al. 2008
Jian and Wong 2010). Especially, in the products or services market, provided that buyers purchase their necessary inputs mostly from the related suppliers without any reasonable comparison for the quality or price of the products or services from non-related suppliers, the related sellers can increase sales volume easily, which may in turn increase their operating income. And this benefit will finally contribute to boosting the wealth of their shareholders, thereby widening wealth inequality and deteriorating fair competition in the industry. As a way to curb abnormal level of RPS transactions, regulators introduced gift taxes on the benefits tunneled through these transactions in 2012, which is levied to the ultimate individual controlling shareholders. Below, I briefly explain the two essays in my dissertation.
The first essay examines whether and how managers reduce RPS transactions after the enforcement of gift taxes on RPS. Prior studies present the competing hypotheses for the role of RPT. “Efficiency enhancing view” argues that firms engage in RPT with intent to reduce transaction costs in an imperfect market. On the other hand, “tunneling view” posits that RPT is a viable channel for transferring the wealth within a business group into the ultimate shareholders. From the tunneling view, the Korean regulators have had long concerns over abnormal amounts of RPS, and enforced gift taxes on the benefits tunneled through these transactions in 2012, which are levied to the ultimate individual controlling shareholders. Since such taxes increase with the ratio of RPS to total sales above 30%, the sellers (beneficiary firms) whose shareholders are expected to pay the gift taxes may have incentives to reduce RPS after 2012. However, this tax incentive may conflict with the purpose to enhance business efficiencies through RPS.
Using 1,456 firm-year observations over 2010-2013 and employing a difference-in-differences approach, I find that beneficiary firms are likely to reduce their RPS transactions after 2012, compared with non-beneficiary firms. However, this phenomenon is pronounced solely in the abnormal components of RPS estimated based on Jian and Wong’s (2010) methodology, not in its normal components. In addition, it is documented that the tendency of beneficiary firms to reduce RPS is more prevalent when they are in competitive markets than in non-competitive markets, or when the individual controlling shareholders have a higher percentage of ownership. These results suggest that gift taxes on RPS seem to induce managers of beneficiary firms to reduce RPS transactions, especially when the resulting non-tax costs of losing business efficiencies (the following tax savings) are expected to be lower (higher).
In the second essay, I examine whether and how managers manage operating income (OI) in response to the introduction of gift taxes on RPS. Prior literature documents that managers opportunistically shift items within the income statement (e.g. classifying operating expenses as non-operating expenses) to inflate core earnings. The second essay examines whether a firm changes its classification shifting (CS) behaviors driven by the tax incentive of its controlling shareholders. In Korea, if a firm recognizes abnormal levels of RPS after 2012, its individual controlling shareholders should pay gift taxes on the benefits tunneled through such transactions. And the taxable amount is calculated based on the after-tax OI generated by RPS that exceed 30% of total sales. This suggests that controlling shareholders of beneficiary firms may pressure managers to manipulate OI downward. However, this tax incentive may conflict with financial reporting incentive to inflate OI.
Using 1,460 firm-year observations from 2010 to 2013 and employing a difference-in-differences approach, I find that beneficiary firms exhibit a significant decline in OI-inflating CS activities after 2012, compared with non-beneficiary firms. Furthermore, this phenomenon tends to be more prominent when beneficiary firms do not finance in the public market, or when the percentage of shares owned by individual controlling shareholders is higher. These results suggest that gift taxes on RPS seem to deter managers from engaging in OI-inflating CS activities, especially when the financial reporting concerns over how to report OI are lower, or when the resulting tax savings are expected to be higher.