Measuring abnormal pricing – an alternative approach. The case of US banana trade with Latin American and Caribbean Countries
| Pages | 203-218 |
| Published date | 06 May 2014 |
| Date | 06 May 2014 |
| DOI | https://doi.org/10.1108/JMLC-11-2013-0043 |
| Author | Keejae Hong,Cabrini H. Pak,Simon J. Pak |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial compliance/regulation |
Measuring abnormal pricing – an
alternative approach
The case of US banana trade with Latin
American and Caribbean Countries
Keejae Hong
Belk College of Business, University of North Carolina at Charlotte,
Charlotte, NC, USA
Cabrini H. Pak
School of Business and Economics, The Catholic University of America,
Washington, DC, USA, and
Simon J. Pak
School of Graduate Professional Studies, Penn State University, Malvern,
PA, USA and President, Trade Research Institute, Inc., USA
Abstract
Purpose – The purpose of this study is to examine the degree of trade mispricing in the US fresh
banana trade with Latin American and Caribbean countries using a new alternative measure in
estimating arm’s length price.
Design/methodology/approach – A key feature of the research design is that we use the actual free
market price of commodity (e.g. fresh banana price) as a benchmark for arm’s length price rather than
relying on interquartile range, which is known to be problematic.
Findings – The paper nds that when the degree of mispricing is measured by two widely used
methods, interquartile price lter and partner-country methods, we nd little evidence of
undervaluation or overvaluation of US banana import. However, when we use the free-market price of
fresh banana as a benchmark for arm’s length price, rst adopted in this study, the average undervalued
amount of trade compared to the total banana import declared value by the US importers is on average
54 per cent during the period between 2000 and 2009.
Originality/value – This study suggests a new simple measure in estimating arm’s length traction
price in studying trade mispricing.
Keywords Tax evasion, Transfer pricing, Abnormal trade pricing, Trade mispricing, Banana trade
Paper type Research paper
1. Introduction
The US import record on bananas exhibits signicant price anomalies compared to the
free market import prices of bananas reported by United Nations Conference on Trade
The authors beneted from the comments of the participants at the presentation of an earlier draft
at the 7th International Critical Management Studies Conference, Critical Accounting Stream,
University of Naples Federico II, Naples, Italy. July 11-13, 2011, and wish to express their
appreciation to the participants.
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1368-5201.htm
Measuring
abnormal pricing
203
Journal of Money Laundering Control
Vol. 17 No. 2, 2014
pp. 203-218
© Emerald Group Publishing Limited
1368-5201
DOI 10.1108/JMLC-11-2013-0043
and Development (UNCTAD)/International Monetary Fund (IMF). For example, the US
import record shows that the USA imported 9,847 tons of bananas from Costa Rica in
November 2009 with a declared customs value of USD2.2 million (USD2.3 million c.i.f.).
The unit value based on the declared import value is therefore 24 cents/kg (c.i.f. basis).
This is signicantly below the free market prices of 83 cents (importer’s price, f.o.b. US
ports, reported in the commodity price statistics, UNCTAD)[1]. The market value of this
particular import is USD8.2 million based on the free market importer’s price. Therefore,
it appears that the US importer paid the exporter in Costa Rica less than the market
value by about USD6 million.
One possible explanation for such a discrepancy is trade mispricing which is often
used to shift capital out of an exporting country and to reduce taxable income in the
exporting country[2][3]. Abnormal pricing or mispricing can occur when companies set
“prices” for related party transactions different from arm’s length transaction prices.
Prior studies provide theoretical arguments as well as empirical evidence as to why
multinational companies set the “transfer price” in related party transactions different
from third-party transaction prices. For example, income shifting from countries with a
higher marginal tax rate to countries with a lower marginal tax rate is a commonly
known reason for abnormal pricing (Eden, 1998;Samuelson, 1982;Halperin and
Srinidhi, 1987;Harris and Sansing, 1998;Hines, 1997). Capital transfer is another factor
inuencing a rm’s decision to set a specic level of transfer price in related party
transactions (de Boyrie et al., 2005a). Sikka and Willmott (2010) examine extensively the
transfer price practices used by multinational corporations and report a widespread use
of transfer pricing to avoid taxes and to shift income in both developed and developing
countries.
Due to the abusive use of transfer price and a large impact on a country’s tax revenue,
a great deal of attention has been given to trade mispricing by both academics and
regulators in recent years (Bhagwati, 1964;1974;de Boyrie et al., 2005a,2005b;de Boyrie
et al., 2007;Gulati, 1987;Pak, 2007;Zdanowicz et al., 1999)[4]. Largely invisible to the
public eye and costly to detect (Sikka and Willmott, 2010), such abuse can be
particularly damaging to exporting developing countries where capital ight adversely
affects their potential for economic and social development. An unresolved issue in
examining trade mispricing studies is how to measure an arm’s length price.
Measurement of an arm’s length price is an important issue, as mispricing is measured
by any deviation from the arm’s length price. Among many different methods proposed
in identifying trade mispricing, the partner-country and interquartile price lter
methods have been most widely adopted. In the absence of arm’s length price data, those
two methods offer one way to calculate mispriced amounts as a tentative and rst-order
approximation, requiring follow-up analysis and investigations for accuracy.
In this study, we propose an alternative price lter method by replacing the
interquartile price range with the free market price to measure the degree of abnormal
pricing in the US import of fresh bananas through a detailed analysis of US trade with
Latin American and Caribbean countries (LAC). The main contribution of our study is in
that we rst introduce the free market commodity price to the trade mispricing model
in identifying arm’s length price, while other studies are based on methods that rely on
rather strong (often unrealistic) assumptions that can create measurement errors in
arm’s length price calculation.
JMLC
17,2
204
To continue reading
Request your trial