Chapter 18

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Chapter 18

Corporate Governance, Accounting, and Taxation

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

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IntroductionThe structure and conduct of corporate governance and the methods used in the measurement of company operations, accounting, principles, and practice vary dramatically across countriesTaxation and accounting are fundamentally related

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Corporate GovernanceThe 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

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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 shareholdersThe equity treatment of shareholdersThe role of stakeholders in corporate governanceDisclosure and transparencyThe responsibilities of the board

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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 moneyThe auditors The multitude of regulators

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Auditors and Regulators

Auditors are responsible for providing an external professional opinion as to the fairness and accuracy of corporate financial statementsThese 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

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Comparative Corporate Governance

Corporate governance practices differ across countries, economies, and cultures and may be classified by regime

Market-basedFamily-basedBank-basedGovernment-based

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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 developmentDegree of separation between management and ownershipConcept of disclosure and transparency

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

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Corporate Governance Reform

The debate regarding what needs to be done about corporate governance reform depends on which systems and regimes are deemed superiorTo date, reform in the United States has been largely regulatory

Sarbanes-Oxley ActBoard structure and compensationTransparency, accounting, and auditingMinority shareholder rights

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

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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 makingHindering the ability to raise capital in differing marketsHindering from monitoring competitive factors

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Principal Differences: The Issues

The resulting impact of accounting differences is to separate or segment international markets for investors and firms alikeCommunicating 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 firmNine 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

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Principal Differences: The Issues

Accounting for research and development expensesAccounting for fixed assetsInventory accounting treatmentCapitalizing or expensing leasesPension plan accountingAccounting for income taxesForeign currency translationAccounting for mergers and acquisitionsConsolidation of equity securities holdings

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The Process of Accounting Standardization

There is still some conflict over the terminology of harmonization, standardization, or promulgation of uniform standards1966 study of accounting differences across countries conducted by Accountants International Study Group

First strong movement toward accounting standardization was the establishment of the International Accounting Standards Committee (IASC) in 1973Two other recent developments concerning international standardization merit consideration

General Electric CompanyFinancial Accounting Standards Board (FASB)

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International TaxationGovernments alone have the power to taxGovernments want to tax all companies within their jurisdiction without placing burdens on domestic or foreign companies that would restrain tradeEach 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

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Tax Jurisdictions and Tax Types

Nations usually follow one of two basic approaches to international taxation

Residential approachTerritorial or source approach

Taxes are generally classified one of two ways

Direct TaxesIndirect Taxes

The value-added tax (VAT) is the primary revenue source for the European Union

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Income Categories and Taxation

There are three primary methods used for the transfer of funds across tax jurisdictions

RoyaltiesInterestDividends

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U.S. Taxation of Foreign Operations

The U.S. exercises its rights to tax U.S. residents’ income regardless of where the income is earnedThe 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 taxationThe calculation of foreign income taxes deemed paid and the additional U.S. taxes due involves the interaction of four components

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Calculations of U.S. Taxes on Foreign-Source Earnings: Four

CasesForeign affiliate of a U.S. corporation in a high-tax environmentForeign affiliate of a U.S. corporation in a low-tax environmentForeign affiliate of a U.S. corporation in a low-tax environment, 50 percent payoutForeign subsidiary of a U.S. corporation is a CFC in a low-tax environment

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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. corporationsFuel is being added to the fires of world governments and their shares of the world tax pie