How Does Transfer Pricing Risk Affect Premiums in Cross‐Border Mergers and Acquisitions?

ABSTRACT This study investigates how transfer pricing risk affects the premiums in cross‐border mergers and acquisitions (M&A). Differences in the rigor of transfer pricing enforcement and the severity and clarity of rules across countries create differential risk of material costs for multinationals as they expand globally. We use 448 country‐level transfer pricing risk assessments by global transfer pricing partners and managers from two firms in 33 countries to develop a metric of country‐year transfer pricing risks. The resulting measure of transfer pricing risk is used to analyze the premiums of 3,103 cross‐border M&A from 2000 to 2012. We find that lower bid premiums are associated with higher transfer pricing risk in the target's country. We find the relation is stronger when expected future transfer pricing benefits are larger. Our results, consistent with the views of experts in the field, provide the first archival evidence that acquirers consider synergies created by future tax planning when estimating the value of a target.