payment of intangibles, income shifting and ﬁnancing structure of afﬁliate (Jacob, 1996;
Chang and Lin, 2010;Taylor and Richardson, 2012;Henn, 2013;Brock and Pogge, 2014).
More so, most of these studies reveal that transfer pricing manipulation is the main
avoidance mechanism used by these corporations in an attempt to achieve their goal of
global proﬁt maximization and tax minimization objectives (Gravelle, 2009;Pendse, 2012;
Janský et al.,2013). The manipulation of this transfer pricing occurs when a company in
an attempt to either purchase or sell to an afﬁliated entity under-price or over-price the
goods or service for the reason that the two companiesare located in a variable different tax
jurisdictions (Clausing, 2003;Dyreng and Lindsey, 2009;Slemrod and Wilson, 2009;Cristea
and Nguyen, 2013;Brock and Pogge, 2014). Thismanipulation then offers an opportunity to
the MNCs to relocate proﬁt from countries that these proﬁts originated to countries with
lower tax rates. This effect is frequently observed in the developing economiesas a result of
their human capital inadequacies to deal with the complex nature of transactions
undertaken within afﬁliated entities and inadequate policies to eliminate such practices.
Also, transfer pricing has the propensity to reducethe entitlement of domestic shareholders
and employees due to theunder reporting of proﬁt.
Strands of literature show that tax avoidance behaviour serves as motivation for
earnings management (Graham et al., 2012;Wang and Chen, 2012). Studies on earnings
management have professedthat devices such as changes in accounting procedures, taking
a bath, income maximization and income smoothing are the major instruments that
managers use in managing earnings (Healy, 1985). However, the literature on earnings
management stipulates that in an attempt to manage earnings, ﬁrms structure their
transaction in a way that create differences in the taxable proﬁt and the accounting income
(Hanlon and Heitzman, 2010). These empiricalstudies have outlined that managers manage
earnings so as to report lower proﬁt to pay less tax (Dhaliwal et al., 2004;Desai and
Dharmapala, 2006;Desai and Dharmapala, 2009). These avoidance mechanisms result in
loss of revenue which hinders the ability of the government to undertake its social and
economic responsibilities (Sikka and Willmott, 2010;Otusanya, 2011;Taylor and
Richardson, 2012). According to Desai and Dharmapala (2009), tax avoidance mechanisms
give room for opportunistic managers to pursue self-seeking objectives and manage
earnings in ways that provide beneﬁts to managers and that do not beneﬁt shareholders.
Thus, managers managing earnings are more likely to insulate themselves by avoiding
more taxes as avoidance providesthem shield from shareholder scrutiny. Again, minimized
tax payment leaves excess “after tax”cash ﬂow that can either be distributed as extra
dividends or invested in proﬁtable projects. Although various studies have analysed the
variables of interest and have established relationships among them, these relationships
have been examined independently in most cases. Prior studies have failed to exploit how
the relationship between transfer pricing and earnings management can jointly inﬂuence
tax avoidance behaviour of MNCs. Therefore, the study seeks to examine how transfer
pricing and earnings managementinﬂuence tax avoidance of MNCs operating in developing
countries. It is analysed withinthe Ghanaian context.
The contribution of this study is in two folds: ﬁrst of all, it examines the prevalence of
transfer pricing and earnings management as it pertains to MNCs operatingthe developing
countries. This serves as a response to the calls by prior research for more research on
earnings manipulation and transfer pricing in different economic settings (Healy and
Wahlen, 1999). Second, the study examines the effect of the interaction of the transfer
pricing and earnings managementon tax avoidance.
The rest of the paper is organized as fellows. Section 2 reviews relevant literature on
transfer pricing, earnings management and tax avoidance. Section 3 discusses the research