Profit Shifting and High Ownership Concentration Among Multinational Ghanaian Banks

 Author: Daniel Ofori

Abstract

Purpose: The study aims to examine the effect of high ownership concentration on single jurisdictional tax-motivated income shifting among multinational banks in Ghana. 

Design/Methodology/Approach: A quantitative method has been adopted as the study research approach. For this study, the study collected comprehensive bank data from the bank scope database compiled by the Bank of Ghana for foreign banks. The study made use of a data set of 20 foreign subsidiary banks for 10 years from 2014 to 2023, yielding a total of 200-year–bank observations.  The model considers the natural logarithm of profit before tax and tax incentive.

Findings: The result revealed that Ghanaian bank groups with highly concentrated ownership of the subsidiaries shift income for tax avoidance purposes in higher amounts than groups with less concentrated ownership and with a lower percentage of control. Thus, the alignment that exists between shareholders’ interests and ownership concentration led to a higher level of tax avoidance through subsidiaries’ infra-group transactions. Also, the result indicated that high ownership concentration tends to decrease the minority interest influence which permits the bank shareholders to choose a tax avoidance strategy without any restrictions.   

Keywords: Aggressive Tax Planning, Ghana, Multinationals Companies, Profit Shifting, Transfer Pricing

Introduction:

The shifting of profits by banks is purposely for tax avoidance with the intended objective of maximizing economic benefits (Doo & Yoon, 2020). Hence, when the moment the tax spent is lowered, it increases the net income that is being accrued to the parent firms as well as the minority shareholders (Medioli, Azzali & Mazza, 2023). Therefore, this study hypothesizes that the tax benefits of the parent company’s shareholders are strengthened by a strong level of ownership concentration. Thus, tax-motivated profit shifting is performed by way of transferring profits from high-tax to lower-tax countries (Bird & Karolyi, 2017). Profit shifting arises based on ownership occurs when profit is transferred from low-controlled banks to high-controlled banks (Driffield, Sun, and Temouri, 2018). Parent company shareholders tend to maximize the level of benefits to the detriment of the minority stakeholders by way of shifting profits for both purposes (Driffield et al., 2018).

Prior studies have explored tax avoidance and profit shifting for tax avoidance; however, to the best of the researcher’s knowledge, this subject has not yet fully explored the link between profit shifting and high ownership concentration (Medioli et al., 2020; Farhangdoust, Salehi & Molavi, 2020). Research has shown that there is an indirect link between parent company concentrated ownership and tax avoidance (Richardson et al. 2016). This is attributed to the alignment effect that exists between minority and majority shareholders. However, studies have not fully established situations where parent companies and subsidiaries differentiate profit-shifting for these reasons in cases where affiliate minority shareholders hold less than ten percent of equity (Farhangdoust et al., 2020; Faysal, Salehi & Moradi, 2020). Studies shows that analysis been made of cross-jurisdiction areas (Lim, 2021). The significance of banks groups in Africa, and the chance that these groups and their internal markets are highly associated with greater agency problems prove significant motivation for this study. Studies believed that highly concentrated bank groups are similar to independent banks in which decisions are made without considering the minority ideas and opinions and awarding minorities fiscal benefits (Pham & Nguyen, 2019). Similarly, this can be expressed by the study in the way that tax incentives tend to be stronger in situations of high ownership concentration (Zhao, 2020).

Based on the above-mentioned considerations, the study aims to examine the effect of high ownership concentration on tax-motivated profit shifting and tax avoidance in situations when a bank group has a very low level of minority interests. The study aims to examine whether a high level of ownership concentration leads to alignment between the interests of the minority and the majority in the context of a decrease in tax avoidance. The study concentrates on Ghana as a country in the study setting.  The study analyses parent companies in Nigeria and other European countries, that control subsidiaries in a Ghanaian banking environment. The study performs ordinary least square regression models. The study finds that multinational bank groups with a strong level of ownership concentration shift profit for tax reasons more than multinational groups with dispersed ownership. This is justified based on prior studies’ evidence of profit shifting that exists between subsidiaries and subsidiaries, but not between parent company and subsidiaries (Medioli et al., 2023). The results indicate that a multinational groups with highly concentrated ownership profit shifting occurs at the level of subsidiaries. This is by chance due to the minority owners havinglimited influence and shareholders of the parent company are in a position to choose a strategy of tax avoidance. Thus, the low level of minority stake the banks allows management to choose the best tax-avoidance strategies without considering the interest and protection of the minority owners. 

The study contributes to the body of literature by way of highlighting banks’ strategies that are practiced in line with the ownership structure. The study first describes profits shifting strategy for tax avoidance among Ghanaian bank groups. Additionally, It demonstrates how bank groups’ close alignment of controlling and minority interest does not necessarily decrease tax-motivated profits shifting in the context when ownership is highly concentrated. Finally, empirical evidence concerning the effect of high ownership concentration on tax-motivated profit shifting has been far from conclusion and our results thus make an important contribution to the field. The study consists of eight sections. Section 2 contains a literature review and research hypothesis. Sections 3 describe the research method, the sample. Sections 4 show the correlation matrix and the descriptive statistics, findings and results Section 5 concludes.

Literature Review and Hypothesis Development

Ownership Concentration: 

The literature investigates ownership structure (Hashmi et al., 2018) and its relationship and impacts on different issues (Chung, 2018; Karajeh, 2019). Moreover, prior research also examines different forms of ownership and their relationship with performance, financial structure, disclosure and business strategies (Farhangdoust et al., 2020; Hashmi et al., 2018; Pham and Nguyen, 2019). Driffield et al. (2018) study the relationship between foreign ownership and firm performance, showing that relying on a binary distinction between foreign and domestic firms may lead to distorted conclusions. Faysal et al. (2020) indicate that tax avoidance is higher when there is a big difference between percentages of voting rights and cash flow rights. Lim, (2021) shows that tax evasion and the cost of debt are negatively associated and that the presence of institutional owners strengthens this negative association. Hence, shocks to institutional ownership can reduce the effective tax rate and facilitate tax planning using subsidiaries (Hashmi et al., 2018). 

Furthermore, the biggest decreases are observed among high effective tax rate firms, and the biggest increases among low effective tax rate firms, which is consistent with the finding that institutional ownership pushes firms toward a common level of tax avoidance (Bird & Karolyi, 2017). Increases in the level of institutional ownership are thus associated with increases in tax avoidance, which also has implications for the effect of increased ownership concentration on tax avoidance (Khan et al., 2017). In multinational groups, Faccio and Lang (2022) examine the theory which holds that high control rights lead to significant benefits at the expense of minorities. Young et al. (2018) explore the effects of the entrenchment vs alignment theories in pyramidal structures and opaque governance contexts. Results mainly show that entrenchment allows parent company shareholders to expropriate minorities in subsidiaries. On the other hand, where there is alignment between control and minority shareholders, expropriation of minorities is mitigated (Carney et al., 2017). 

From a similar point of view, Gomes (2000) states that shareholders use ownership concentration to “send a good message” outside the company. This is a further demonstration of the alignment effect: increasing concentration over the necessary level contributes to reduce tax avoidance behaviors and opportunism. Despite these meaningful results, they however concern a single country with the same tax rate for all companies. Moreover, the study does not examine highly concentrated firms, in which majority power is incontrovertible. There appear however to be no existing studies on the relation between tax-motivated income shifting and ownership concentration with controlling percentage higher than 90%. This research aims to fill this gap, investigating the Ghanaian banking context and considering high levels of ownership concentration. Moreover, the analysis looks at tax-motivated income shifting in single country tax avoidance. The study aims to extend Huizinga and Laeven (2018) by testing the enhancing effect of ownership on income shifting carried out for tax reasons, as a method of tax avoidance.

Conceptual Framework: 

The conceptual framework of the study was developed using hypothesis development concerning the objectives of the study. The conceptual framework was developed using independent variables as well as dependent variables.  In this research, the diagram shows the relationship between the dependent variables as a result of the interplay of the independent variables. The conceptual framework is shown in Figure 1 and serves as an illustration of the framework around which the entire project is built. 

Tax-Motivated Income Shifting among Subsidiaries and Ownership Concentration:

Information asymmetry leads the agent to engage in behaviors to expropriate the welfare of the principal (Shleifer & Vishny, 2017). Where there is a separation between ownership and control (Jensen and Meckling, 1976) controlling shareholders may have the incentive and the ability to expropriate minorities. Moreover, the use of internal markets inside a group is associated with agency problems (Leuz et al., 2009). In light of the above, a very low presence of minority shareholders increases the incentive to look for tax advantages. Therefore, a strong relation with high ownership concentration. In high ownership concentration, the alignment effect becomes less important and there are greater efforts towards tax-motivated income shifting because controlling shareholders are subject to fewer objections from minority shareholders and can obtain all benefits.

 The study investigates the tax incentive to shift income at the subsidiary level (H1) and between the parent and its subsidiaries (H2). Therefore, a very low presence of minority shareholders increases the incentive to look for tax advantages, the study expects to find a strong relation with high ownership concentration. In high ownership concentration, the alignment effect becomes less important and there are greater efforts towards tax-motivated income shifting, because controlling shareholders are subject to fewer objections from minority shareholders and can obtain all benefits. The study argues that the U-shaped pattern identified in shareholdings may continue and change again after 90% in groups with highly concentrated ownership. These arguments lead us to propose:

H1: Tax-motivated income shifting among subsidiaries is stronger when ownership is highly concentrated.

H2: Tax-motivated income shifting between parent company and its subsidiaries is stronger when ownership is highly concentrated.

Research Method

Research Approach:

A quantitative research approach was employed based on the nature of the problem and evidence from previous literature. The justification for adopting the quantitative approach is that it helps produce results clearly through numbers and statistics. Again, it ensures that numerical data is being expressed through hypothesis analysis. Finally, the approach provides a generalization of results which allows for flexible means of collecting and analyzing data information.

Data and Data Collection Instruments:

 The study’s target population concerning the study was 20 foreign subsidiary multinational banks within 10 years from 2014 to 2023. A subsidiary bank is defined in this study as a bank in which at least 50% of the shares are owned and controlled by the parent company (Chen, 2021). The basis of selecting the firms was done through the availability of data information. For this study, the study type of data was obtained through secondary data. The motivation for the choice of the said data is based on the credibility of the data collected. The secondary data was solicited from selected multinational banks in Ghana with annual reports of ten (10) years ranging from 2014 to 2023, yielding a total of 200-year–bank observations. 

Model 

Farhangdoust et al. (2020) suggest that each entity discloses both real profits and profits achieved from income shifting. Readers cannot distinguish between them; thus, real profit is unknown and has to be estimated. They use the Cobb–Douglas production function to evaluate profits of economic activity. In line with Hines and Rice (1994), real profit is calculated by subtracting labor costs from the total output. They built a model that proposes the reported income as a function of capital inputs and labor, productivity, tax incentive, and opportunity. Following Markle (2016), the model used for hypotheses one (1) and two (2) introduces an indicator variable and its interaction with tax.

The study used the natural logarithm of profit before income tax expense (PBT) as our dependent variable. Following Markle (2016), the variable is always positive and measures the level of income shifting that multinational groups perform for tax avoidance purposes. C represents Tax Incentive and is defined by following prior studies (Beuselinck et al., 2018; Markle, 2016; De Simone, 2016). Following Farhangdoust et al. (2020), tax incentive is split into two variables:  one represents the tax difference of a subsidiary vis-à-vis its parent firm (C parent) and the other represents the (weighted) sum of the tax difference vis-à-vis subsidiaries in other (foreign) countries (C subsidiaries).  In case of a tax convenience to move income among subsidiaries, b of C subsidiaries should be negative. 

In other words, a negative relationship means that an income shifting strategy among subsidiaries and motivated by tax exists. In case of a tax convenience to move income between the parent and the subsidiary, b of C parent should be negative; in other words, a negative relationship means that an income shifting strategy between the parent and the subsidiary motivated by tax exists. Ownership90 is a dummy variable that takes value 1 when the subsidiary is owned at 90% or more and 0 otherwise. Variable C subsidiaries Ownership90 is derived from the multiplication of C subsidiaries and Ownership90. 

Looking at the interpretation of this variable, if the tax convenience of moving income among subsidiaries is emphasized by Ownership90, b of C subsidiaries Ownership90 should be negative; in other words, a negative relationship means that greater tax-motivated income shifting occurs among subsidiaries if the control of the parent on the subsidiary is higher than 90%. The same parent can have more than one subsidiary. If the parent controls the subsidiary by more than 90%, we expect that the parent will do more income shifting among subsidiaries. If the parent controls the subsidiary at less than 90%, we expect that the parent will do less income shifting among subsidiaries.

The study uses the same control variables in the literature (Huizinga and Laeven, 2018; Markle, 2016). The study used tangible fixed assets in thousands of cedis at the end of the fiscal year as a proxy of capital. The study also used the variable compensation expense as a  cost of salaries in thousands of cedis at the end of the fiscal year as a proxy of labor. The use of gross domestic product (GDP) as an adequate indicator of productivity (Markle, 2016). Finally, the study included parent-firm fixed  effects to control systematic differences in reported income and year fixed effect.

Results and Discussions

Introduction: 

This chapter of the study presents the results and discussion of the study. The primary focus of the study’s analysis was to discuss the results and findings. 

Pearson Correlation Matrix:

The section of the study presents the Pearson correlation matrix in line with the variables under study as shown in Table 1. 

Based on the result indicated in Table 1, the study indicated that all the variables’ coefficients are less than 0.60. This implies that the data and results obtained do not have a problem with the multicollinearity of the variables under discussion.

Tax-Motivated Income Shifting Among Subsidiaries is Stronger with Ownership Highly Concentrated:

The study revealed the results of multivariate regression concerning profit-shifting as shown in Table 2 in Model 1. The result revealed an adverse relation between C subsidiaries and profit before tax (coefficient -0.112, p-value 0.002). Therefore, the result shows that C subsidiary is calculated such that a negative value indicates a tax incentive to shift profit among controlled firms. Thus, an adverse value is interpreted as profit shifting for tax avoidance reasons. On the other hand, the results of Model 2 show the coefficient on C parent is statistically significant (coefficient -0.494, p-value 0.008). Based on this, the adverse link defines the existence of a profit-shifting strategy between the parent and the subsidiary motivated by the tax. In other words, this confirms results from prior literature by Faysal et al., 2020; Karajeh, 2019; Bird and Karolyi, 2017) who indicated that prior results show that income shifting at the parent and subsidiary level is widely performed by multinational groups for tax avoidance purposes.

Concerning the results shown in Table 3 with regards to Model 3 which test H1 with the interaction of “C subsidiaries” with “Ownership90” and Model 4 with the interaction between “C parent” and “Ownership90.” Based on this, the result in Model 3 shows an adverse relationship between “C subsidiary” and “Ownership90” and the natural logarithm profit before tax (coefficient -0.127, p-value 0.001). This indicates that firms owned at least 90% shift more profit among subsidiaries than firms owned at less than 90%. However, the results in Model 4 test H2 indicated an insignificant relationship between “C parent-Ownership90” and profits before tax (coefficient 0.195, p-value 0.795). There is no evidence that firms owned at least 90% shift income differently between parent and subsidiaries compared to firms owned at less than 90%. In other words, these results show that tax avoidance through profit shifting is stronger in international banks based in Ghana with a high level of ownership concentration, at the subsidiary level. On the other hand, at the level of parent companies, there are no significant results, probably because the foreign countries of parent companies have similar taxation rates.

Additionally, agency conflict between controlling shareholders and minorities plays a crucial role and company ownership structure exerts an influence on strategies and opportunistic choices. The results confirmed that business groups may see higher levels of agency conflict, especially when different categories of minority are involved and they have low decisional power, as is the case for the banks in the study sample where minority shareholders hold less than 10% of equity. Agency theory in fact holds that information asymmetry may enable and even encourage controlling shareholders to expropriate minority shareholders. The results indicated that a very low presence of minority shareholders increases the incentive for the majority to look for tax advantage, and the tendency to take the available opportunity. In other words, the alignment effect becomes less important, and more effort is made toward tax-motivated income shifting because controlling shareholders are subject to fewer objections from minority shareholders and can obtain all benefits.

The study findings contribute to the literature, extending the findings of Huizinga and Laeven, (2018), by showing that the incentive to shift income is confirmed only at the level of subsidiaries and where variation in taxation levels can explain the strategy. The study suggests that in researching profit shifting strategy, it is important to take account of context and the taxation rate of parent companies and subsidiaries, which were ignored by prior literature. This study also extends the findings of Richardson et al. (2016) showing that in European multinational groups, the alignment between parent company and minority interests does not reduce the amount of tax-motivated profit shifting when ownership is highly concentrated. On the contrary, subsidiaries controlled by parent companies by more than 90% perform more tax avoidance activities by shifting their profit from high-tax to low-tax countries. Extending the analysis to include minority interests less than 10%, the study provides a possible explanation for their possibly controversial result. In fact, when minorities become insignificant, the parent company meets fewer obstacles to shifting more income for tax avoidance purposes and managers have incentives to push the benefits of parent company owners. In cases where income is shifted from low controlled to high controlled companies, ownership reasons appear to complement tax avoidance purposes. This result is useful in light of conflicting prior findings. On the basis of the study, the result provides clear confirmation of H1 of the study: concentrated multinational groups shift more income than dispersed multinational groups with the same tax incentives and opportunities. Hence, the hypothesis is also confirmed for tax avoidance by using profit shifting between subsidiaries but not between parent and subsidiaries. 

Conclusions and Recommendations  

Conclusion:  

The study aimed to examine the effect of high ownership concentration in multinational groups on tax-motivated income shifting among Multinational Ghanaian Banks. The study uses a data set from the Bank scope Database compiled by the Bank of Ghana of the banks in Ghana. The approach and method of previous studies are followed, and the study regresses the panel data set from 2014 to 2023.

The study concluded that where ownership is highly concentrated, the alignment effect becomes weaker. Tax-motivated profit shifting becomes more important as the controlling shareholder meets fewer obstacles, or no obstacles at all when the minority is completely absent and can obtain all the benefits. The study concluded that both subsidiaries and parent companies take income-shifting measures to avoid tax. Hence, the testing of the study hypotheses, the study concluded that in Ghanaian bank groups with highly concentrated ownership, the subsidiaries shift profit for tax avoidance purposes in higher amounts than groups with less concentrated ownership and with lower percentage of control.

The study made some contributions. The study suggests that research into tax avoidance strategies performed with income shifting needs to take into account the levels of taxation in different countries. Also, the study suggests that group ownership concentration is relevant to the business strategy related to the profit shifting activities. In Ghanaian groups with very high levels of minorities, they show that the parent company appears to be free to follow tax avoidance strategies, which agrees with prior results. The results indicate that a very low level of minority interests allows the parent company to follow the best tax-motivated strategy, without running risks related to expropriation of benefits from other shareholders. These findings thus extend the strand of research on ownership concentration as well as the strand on profit shifting strategy motivated by tax. 

The study contributes by indicating that banks managements may ignore minority interests not well protected by law and regulation; on the other hand, they have the incentive to maximize tax benefits for the parent company shareholder and are aware that the best way is without       minority interests. As most developing countries have recently approved laws and regulations to improve the protection of minority interests, it is likely that management motivation will prevail.

Recommendations: 

The study recommends that public policy related to the role of auditors in Ghana can have a significant impact on the tax avoidance behaviour of MNEs in the country. This will help improve corporate tax and revenue generation of the country. 

Suggested Areas for Future Studies:

Future research should employ comparative approaches. The study can accomplish this by incorporating from neighbouring countries into the study in order to expand its scope. Also, the study raises interesting questions for future studies. It would be particularly interesting to examine other characteristics besides ownership structure that impact on income shifting strategy and also focus on other countries

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