Corporate Governance, Accounting, and Taxation Chapter 18 Corporate Governance, Accounting, and Taxation

Learning Objectives To explore the purpose and structure of corporative governance as it is practiced globally To examine the failures in corporate governance in recent years and how authorities are responding to these changes To understand how accounting practices differ across countries and how these differences may alter the competitiveness of firms in international markets To isolate which accounting practices are likely to constitute much of the competitiveness debate in the coming decade To examine the primary differences in international taxation across-countries and in turn how governments deal with both domestic and foreign firms operating in their markets To understand problems faced by many U.S.-based multinational firms in paying taxes both in foreign countries and in the United States.

Introduction The structure and conduct of corporate governance and the methods used in the measurement of company operations, accounting, principles, and practice vary dramatically across countries Taxation and accounting are fundamentally related

Corporate Governance The relationship among stakeholders used to determine and control strategic direction and performance of an organization is termed corporate governance The way in which order and process is established to ensure that decisions are made and interests are represented properly for all stakeholders

The Goal of Corporate Governance The single overriding objective of corporate governance is the optimization over time of the return to shareholders The most widely accepted statement of good corporate governance practices are those established by OBECD The rights of shareholders The equity treatment of shareholders The role of stakeholders in corporate governance Disclosure and transparency The responsibilities of the board

The Structure of Corporate Governance The internal forces, the officers of the corporation and the Board of directors, are those directly responsible for determining the strategic direction and the execution of the company’s future The external forces include: The equity markets The analysts The creditors and credit agencies who lend them money The auditors The multitude of regulators

Auditors and Regulators Auditors are responsible for providing an external professional opinion as to the fairness and accuracy of corporate financial statements These individuals follow the generally accepted accounting principles Regulatory oversight of publicly traded firms in the U.S. is provided by governmental and nongovernmental agencies Securities and Exchange Commission (SEC) Applicable stock exchange

Comparative Corporate Governance Corporate governance practices differ across countries, economies, and cultures and may be classified by regime Market-based Family-based Bank-based Government-based

Comparative Corporate Governance (cont.) Corporate governance regimes are a function of three major factors in the evolution of global corporate governance principles and practices Financial market development Degree of separation between management and ownership Concept of disclosure and transparency

The Case of Enron Many of the issues related to corporate governance and its failures are best described by the Enron case Enron Corporation declared bankruptcy in November 2001 as a result of a complex combination of business and governance failures

Corporate Governance Reform The debate regarding what needs to be done about corporate governance reform depends on which systems and regimes are deemed superior To date, reform in the United States has been largely regulatory Sarbanes-Oxley Act Board structure and compensation Transparency, accounting, and auditing Minority shareholder rights

Accounting Diversity The fact that accounting principles differ across countries is not, by itself, a problem The primary problem is that real economic decisions by lenders, investors, or government policymakers may be distorted by the differences

Principal Accounting Differences Across Countries International accounting diversity can lead to problems in international business conducted with the use of financial statements Poor or improper decision making Hindering the ability to raise capital in differing markets Hindering from monitoring competitive factors

Principal Differences: The Issues The resulting impact of accounting differences is to separate or segment international markets for investors and firms alike Communicating the financial results of a foreign company operating in a foreign country and foreign currency is often a task that must be undertaken separately from the accounting duties of the firm Nine major areas of significant differences in accounting practices across countries serve to provide understanding of this issue and highlight some of the major philosophical differences

Principal Differences: The Issues Accounting for research and development expenses Accounting for fixed assets Inventory accounting treatment Capitalizing or expensing leases Pension plan accounting Accounting for income taxes Foreign currency translation Accounting for mergers and acquisitions Consolidation of equity securities holdings

The Process of Accounting Standardization First strong movement toward accounting standardization was the establishment of the International Accounting Standards Committee (IASC) in 1973 Two other recent developments concerning international standardization merit consideration General Electric Company Financial Accounting Standards Board (FASB) There is still some conflict over the terminology of harmonization, standardization, or promulgation of uniform standards 1966 study of accounting differences across countries conducted by Accountants International Study Group

International Taxation Governments alone have the power to tax Governments want to tax all companies within their jurisdiction without placing burdens on domestic or foreign companies that would restrain trade Each country will state its jurisdictional approach in the tax treaties it signs with other countries Treaties establish the bounds of jurisdiction to prevent double taxation

Tax Jurisdictions and Tax Types Nations usually follow one of two basic approaches to international taxation Residential approach Territorial or source approach Taxes are generally classified one of two ways Direct Taxes Indirect Taxes The value-added tax (VAT) is the primary revenue source for the European Union

Income Categories and Taxation There are three primary methods used for the transfer of funds across tax jurisdictions Royalties Interest Dividends

U.S. Taxation of Foreign Operations The U.S. exercises its rights to tax U.S. residents’ income regardless of where the income is earned The income of a foreign branch of a U.S. corporation is treated the same as if the income was derived from sources within the U.S. Corporations operating in more than one country are subject to double taxation The calculation of foreign income taxes deemed paid and the additional U.S. taxes due involves the interaction of four components

Calculations of U.S. Taxes on Foreign-Source Earnings: Four Cases Foreign affiliate of a U.S. corporation in a high-tax environment Foreign affiliate of a U.S. corporation in a low-tax environment Foreign affiliate of a U.S. corporation in a low-tax environment, 50 percent payout Foreign subsidiary of a U.S. corporation is a CFC in a low-tax environment

Concluding Remarks Regarding U.S. Taxation of Foreign Income Recent accounting and tax rule changes may actually result in worsening the effective tax rate and excess foreign tax credit problem for U.S. corporations Fuel is being added to the fires of world governments and their shares of the world tax pie