Corporate Governance, Accounting, and Taxation

CHAPTER 18

CORPORATE GOVERNANCE, ACCOUNTING, AND TAXATION

Chapter Objectives

• To explore the purpose and structure of corporate 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 the problems faced by many U.S.-based multinational firms in paying taxes both in foreign countries and in the United States

Opening Case
Corporate Inversion and Stanley Works
Summary:
This case tells how Stanley Works tried to do a corporate inversion, that is re-incorporate itself as a Bermuda-based corporation with all U.S. operations becoming a wholly-owned subsidiary. This move would have saved Stanley about $30 million annually in taxes. However, due to public outcry as well as opposition from employees, stockholders, and federal authorities, Stanley gave up on the move.

Chapter Outline

I.Corporate Governance—the relationship among stakeholders used to determine and control the strategic direction and performance of an organization

1. The Goal of Corporate Governance
2. The optimization over time of the returns of shareholders
3. To develop and implement strategy that ensures corporate growth and improvement in the value of the corporation’s equity
4. OECD statement of good corporate governance practices
5. Protect shareholders’ rights
6. Ensure equitable treatment of all shareholders
7. Recognize the rights of stakeholders and encourage active cooperation with them
8. Ensure that timely and accurate disclosure is made on a material matters
9. Ensure strategic guidance by the board and its accountability to shareholders
10. The Structure of Corporate Governance (Figure 18.1, page 594)
11. The Internal Forces
12. The Board of Directors
13. Officers and Management
14. External Forces
15. Equity Markets—analysts depend on financial statements and other public disclosures to evaluate firm
16. Debt Markets—also rely on disclosures to evaluate company’s financial health
17. Auditors—must provide external professional opinion as to the fairness and accuracy of corporate financial statements
18. Regulators—watchdogs over the company and its stock trading
19. Comparative Corporate Governance (Table 18.1, page 596)
20. Corporate governance structures classified by regime
21. Market-based regimes—relatively efficient capital markets in which ownership is widely dispersed
22. Family-based regimes—largely controlled by families
23. Bank-based regimes—government influence in bank lending, family controlled, and practically no private ownership of stock
24. Government-based regimes—state ownership of enterprise
25. Financial Market Development—the depth and breadth of capital markets is critical to the evolution of corporate governance practices
26. Separation of Management and Ownership avoids agency issues
27. Disclosure and Transparency
28. The Case of Enron

Focus on Ethics
Enron’s Board on What Happened at Enron
Summary:
This statement by Enron’s board says that the blame for what happened is widespread and could and should have been prevented.

1. Reported earnings were false
2. All of debt was not disclosed
3. Massive compensation packages and bonuses were paid to corporate officers
4. How this all happened—
5. Executive officers managed the board toward own goals
6. Board failed to protect shareholder interests
7. Auditors committed serious errors in judgment
8. Analysts were blinded by the euphoria over successes
9. Good Governance and Reputation
10. It could have prevent the Enron disaster
11. Decides where capital should go
12. Affects the company’s reputation and image

1. Corporate Governance Reform
2. Subanes-Oxley Act of 2002
3. CEOs must vouch for veracity of published financial statements
4. Boards must have audit committees drawn from outside directors
5. Prohibits loans to corporate officers and directors
6. Board Structure and Compensation
7. Some advocate not allowing CEO to be Chairman of Board
8. Some advocate the formulation of a supervisory board (largely outsiders) and a management board (insiders)
9. Some advocate not giving stock options to board members
10. Transparency, Accounting, and Auditing
11. Transparency—the degree to which an investor can discern the true activities and value drivers of a company from disclosures
12. Accounting—some argue it should not be rule-based, but conceptually based as in Western Europe
13. Auditing –some argue they should not be paid by the ones the audit
14. Minority Shareholder Rights

II.Accounting Diversity (Table 18.3, page 603)

1. If firms are operating in dissimilar economic situations subject to same accounting treatment, results will appear differently
2. If firms are operating in same economic situations subject to dissimilar accounting treatment, results will appear differently
3. If firms are operating in dissimilar economic situations subject to dissimilar accounting treatment, results will appear differently

III.Principle Account Differences Across Countries

1. Origins of Differences—linked to differences in people, places, events, and laws that have developed

Focus on Culture
The Father of Accounting: Luca Pacioli Who?
Summary:
This focus explains how it is really impossible to say who really invented with the accounting system we all use today.

1. Classification Systems (Figure 18.4, page 605)
2. Micro-based—characteristics of the firms and industries
3. Theoretical
4. Pragmatic (U.S., Canada, Japan, UK, Mexico)
5. Macro-uniform—following fundamental government or economic factors per country (European countries)
6. Principal Differences: The Issues
7. To separate or segment international markets for investors and firms (Table 18.4, page 606)
8. Accounting for Research and Development Expenses
9. Capitalized because there is no guarantee of benefits
10. Expensed because they are an investment for future benefits
11. Accounting for Fixed Assets
12. All countries require these to be capitalized
13. Methods of depreciation vary
14. Debate over fixed assets as historical cost or current value
15. Inventory Accounting Treatment
16. LIFO—Last In First Out
17. Average Cost Method
18. FIFO—First In First Out
19. Capitalizing or Expensing Leases
20. Pension Plan Accounting—Expensed at time employee is working and contributing or expensed only as payments are made after retirement
21. Accounting for Income Taxes—should tax effect be recognized in period the item appears on income statement or when item appears on tax return
22. Foreign Currency Translation—use historical or current exchange rates (Figure 18.5, page 609)
23. Accounting for Mergers and Acquisitions—whether assets and liabilities acquired should be carried at original historic value or value at acquisition and how goodwill (paying more for assets than fair value) should be handled

Focus on Ethics
Corporate Social Responsibility and Starbucks
Summary:
Starbucks was criticized because so many coffee growers were living in poverty. In response it started programs of support for them. It said it was doing this because it was the right thing to do.

1. Consolidation of Equity Securities Holdings—how to account for when one company purchases and holds an investment in another company
2. Equity method—list the security holdings as a line item on balance sheet
3. Consolidation—the addition of all of the investee’s individual assets and liabilities to the company’s assets and liabilities

Focus on Culture
Russia’s Taxing Accounting Rules
Summary:
This focus explains how in Russia with a tradition of control, instead of profit, Russian account regulations were drafted and used for tax calculation and bookkeeping purposes. It reports that the government in Russia has take steps to promote accounting reforms

1. The Process of Accounting Standardization
2. International Accounting Standards Committee (IASC)formed in 1973
3. European Union is trying to harmonize standards between countries
4. In September 3003, the European Commission approved legislation requiring publicly trade companies to comply with International Account Standards by 2005
5. in 1983 GE complied with IASC standards
6. The Financial Accounting Standards Board (U.S.) committed itself to the full consideration of “an international perspective.”

IV.International Taxation

1. Tax Jurisdictions
2. Residential approach—tax the international income of its residents without regard to where the income is earned
3. Territorial approach—tax all parties, regardless of country or residency, within territorial jurisdiction
4. Combination of residential and territorial
5. Tax Types
6. Direct taxes—calculated on actual income
7. Indirect taxes—applied to purchase prices, material costs, quantities of natural resources mined, etc.
8. Value-Added Tax (VAT) (Europe)—tax applied to the amount of the product price less the cost of materials and inputs used in its manufacture

Focus on Ethics
Offshore Centers Under Fire
Summary:
This focus explains how tax havens are a global problem for governments losing taxes due to their existence. They are also considered havens for funds illegally earned and for companies wishing to avoid paying taxes they legitimately owe.

1. Income Categories and Taxation
2. Royalties are under license for the use of intangible assets
3. Interest is the payment for the use of capital lent
4. Dividends are income paid or deemed paid to the shareholders of the corporation
5. Taxation of income differs across countries (Table 18.5, page 614)
6. Corporate income tax rate is applied to all residual earnings
7. Royalty and interest payments to nonresidents are normally subject to withholding taxes
8. Corporate income is usually double taxed-corporation pays and dividend recipients pay

V.U.S. taxation of Foreign Operations—regardless of where the income is earned

1. Taxation of Foreign Branches of U.S. Corporations
2. Treated as if the income was derived from sources within the U.S.
3. If foreign country taxes these branches they receive a tax credit
4. Taxation of Foreign Subsidiaries of U.S. Corporations—reduces tax burden to avoid double taxation depending on--
5. Degree of Ownership and Control
6. Proportion of Income Distributed
7. Whether income is generated by companies actions (active) or through its ownership in another firm (passive)
8. Relative Corporate Income Taxes paid to foreign countries
9. Calculation of U.S. Taxes on Foreign-Source Earnings
10. Degree of ownership and control
11. Proportion of income distributed
12. Active (generating income through on actions) versus Passive (income through ownership in another firm) Income
13. Relative corporate income taxes—foreign tax credit will completely cover U.S. taxes if high enough
14. Calculation of U.S. Taxes on Foreign-Source Earnings (Table 18.6, page 617)
15. Case 1: Foreign Affiliate of a U.S. Corporation in a High-Tax Environment
16. Case 2: Foreign Affiliate of a U.S. Corporation in a Low-Tax Environment
17. Case 3: Foreign Affiliate of a U.S. Corporation in a Low-Tax Environment, 50 Percent Payout
18. Case 4: Foreign Subsidiary of a U.S. Corporation Is a CFC in a Low-Tax Environment
19. Concluding Remarks Regarding U.s. Taxation of Foreign Income
20. An interplay of ownership, distribution, and relative tax rates between countries to determine tax liabilities
21. U.S. corporate income tax rates are among the lowest in the world resulting in foreign tax credits most often (Case 1)
22. Often the tax credit is significantly higher than if the income had been generated in the U.S.