Tax, Financial Reporting, and Tunneling Incentives for Income Shifting: An Empirical Analysis of the Transfer Pricing Behavior of Chinese-Listed Companies

This study examines tax, financial reporting, and tunneling incentives on the transfer pricing decisions of Chinese-listed companies. We use the relative gross profit ratios of related-and unrelated-party transactions to measure transfer pricing strategies. We find evidence supporting the view that transfer pricing is used to (i) increase a listed firm's profits as the corporate income tax rate decreases, (ii) increase a listed firm's profits if its management's compensation is determined by reference to reported profits, and (iii) decrease a listed firm's profits as the percentage of shares owned by the government increases (i.e., the tunneling effect). For those firms that face both tax and tunneling incentives we find that the incentives tend to offset each other such that there is no discernable earnings management.