ABSTRACT Gray markets arise when a manufacturer's products are sold outside of its authorized channels, for instance when goods designated by a multinational firm for sale in a foreign market are resold domestically. One method multinationals use to combat gray markets is to increase transfer prices to foreign subsidiaries in order to increase the gray market's cost base. We illustrate that, when a gray market competitor exists, the optimal transfer price to a foreign subsidiary exceeds marginal cost and is decreasing in the competitiveness of the domestic market. However, a multinational's discretion in setting transfer prices may be limited by mandatory arm's length transfer pricing rules. Provided gray markets exist, we characterize when mandating arm's length transfer pricing lowers domestic social welfare relative to unrestricted transfer pricing. We also demonstrate that gray markets can lead to higher domestic tax revenues, even when gray market firms do not pay taxes domestically.

ABSTRACT In this study, we examine the effect of incentive contract framing on agent effort in an incomplete contract setting. Prior research suggests that when governed by complete incentive contracts, agents exert greater effort under penalty contracts relative to bonus contracts. However, in an incomplete contract setting, in which the incentive contract does not govern all tasks for which the agent is responsible, the agent's trust in the principal is relevant. In this setting, we predict that bonus contracts create a more trusting environment, and this effect spills over to tasks not governed by the incentive contract, such that bonus contracts elicit greater effort on these tasks as compared to penalty contracts. We develop and experimentally validate a theoretical model of the effects of contract frame on trust and effort in this incomplete contract setting. The main intuition behind the model is that the framing of an incentive contract affects the degree to which the contract terms are interpreted by the agent as a signal of mistrust. More specifically, penalty contracts engender greater distrust than do bonus contracts and, therefore, when contracts are incomplete, penalty contracts lead to lower effort on tasks not governed by the contract than do bonus contracts.

ABSTRACT The primary objective of the current study is to empirically reexamine the relation between material weaknesses in internal control (MW) and cost of equity (CE). We direct particular emphasis to the way non-remediation, as well as remediation, of MW affects a firm's CE. This study utilizes a dataset that contains a large sample of second-year MW non-remediation cases, as well as third-, fourth-, and fifth-year non-remediation cases. The findings provide evidence that reporting MW, absent any remediation, in multiple consecutive years has a significant negative impact on CE. However, the current study also shows that the market views favorably a reduction in the number of MW (i.e., partial remediation). Our study helps to reconcile conflicting results in the literature devoted to the relation between MW and CE. JEL Classifications: M41; M42. Data Availability: Available from sources identified within the article.

ABSTRACT This study examines the effects of taxation on the incentives of multinational firms to develop and use intellectual property. We model optimal investment and production decisions by firms that engage in a patent race by making R&D investments. We investigate how taxes affect the level and efficiency of R&D investments, and how these effects depend on whether the winner of the patent race uses it by either producing in the country in which the patent was developed (the domestic country) or in a foreign country. A higher domestic tax rate decreases investment in R&D if production occurs in the domestic country, but increases investment in R&D if production occurs in the foreign country. The present value of domestic tax revenues is strictly positive if production occurs in the domestic country, but is weakly negative if production occurs in the foreign country.

ABSTRACT This paper investigates managerial discretion in compensation decisions in a team setting, in which a measure of the team's aggregate performance is readily available from the accounting system. Specifically, we examine the willingness of managers to obtain additional, costly information that would supplement this measure and allow the managers to more accurately assess individual contributions to team output. Using theory from behavioral economics that incorporates social preferences (i.e., fairness and trust reciprocity) into the managers' utility function, we predict and demonstrate experimentally that managers' willingness to obtain the costly information increases as the team's aggregate performance becomes a more noisy measure of individual performance. Further, we predict and demonstrate that managers' willingness will be greater for relatively high versus relatively low levels of aggregate performance. The study contributes to the literature on subjective performance evaluation by identifying how social preferences influence managers' use of discretion in evaluation processes. Data Availability: The data from this study and the set of instructions for the experimental task are available from the researchers upon request.

ABSTRACT We extend research on the determinants of corporate tax avoidance to include the role of Internal Revenue Service (IRS) monitoring. Our evidence from large samples implies that U.S. public firms undertake less aggressive tax positions when tax enforcement is stricter. Reflecting its first-order economic impact on firms, our coefficient estimates imply that raising the probability of an IRS audit from 19 percent (the 25th percentile in our data) to 37 percent (the 75th percentile) increases their cash effective tax rates, on average, by nearly two percentage points, which amounts to a 7 percent increase in cash effective tax rates. These results are robust to controlling for firm size and time, which determine our primary proxy for IRS enforcement, in different ways; specifying several alternative dependent and test variables; and confronting potential endogeneity with instrumental variables and panel data estimations, among other techniques. JEL Classifications: M40; G34; G32; H25.

ABSTRACT This study finds evidence that public-company reporting by U.S. multinational corporations (MNCs) creates disincentives to repatriate foreign earnings to the U.S. and contributes to the accumulation of cash abroad. MNCs operate under U.S. international tax laws and financial reporting rules and face two potential consequences when they repatriate foreign earnings: a cash payment for repatriation taxes and a reduction in reported accounting earnings. Using a confidential dataset of financial and operating characteristics of foreign affiliates of MNCs combined with public-company data, we examine how repatriation amounts vary across firms that face relatively strong reporting incentives to defer an accounting expense. Our results suggest that reporting incentives reduce repatriations by about 17 to 21 percent annually. Data Availability: Bureau of Economic Analysis (BEA) data were made available to the authors under a legal confidentiality arrangement; all non-BEA data are available from public sources.