Why Companies Performing as Subsidiaries in Australia Look to Bring Forward Lower Profits - Case Study Example

Abstract The paper analyzes the reason why companies performing as subsidiaries in Australia look to bring forward lower profits. Subsidiary companies through the process of intercompany transfers reduce the profits by increasing the expenses. It is also seen that some organizations bring forward the correct profits and don’t look towards altering the actual profits. The reason for the above situation is being analyzed through the agency and legitimacy theory. It is seen that the agent looks to act towards protecting the interest of the principal owner which has thereby resulted in lowering the profits of the subsidiaries. The agency theory shows that agent should act towards protecting the interest of the principal owner which they have addressed. In addition to it both the agent and the principal owner have the same objective which has thereby made the agent to protect the interest of the principal owner. This has thereby resulted in lower profits being highlighted by the subsidiaries. On the other hand some organizations highlight the correct profits because they look to protect the interest of the stakeholders. In addition to it the organization understands that it their morally responsibility to ensure that the community is properly compensated which thereby requires that correct taxes are paid thereby ensuring that the correct profits are highlighted. The paper also shows that using the legitimacy theory will ensure that organizations take decisions based on certain beliefs and is desirable. This will ensure that organizations act fairly and bring forward the correct profits by acting morally correctly as it will deem the action to be desirable. The theory will ensure that organizations understand that they work in the correct manner and would thereby help to bring forward the correct profits and would help the organization to act fairly. Table of Contents Introduction 3 Agency Theory 3 Legitimacy Theory 7 Conclusion 7 References 9 Introduction There are many Australian multinational companies who have lower profits despite large revenues. The Australian Tax Office (ATO) perceives that multinational companies through the process of intercompany transfer looks at maximizing expenses so that profits are low. This will help the company to save on taxes and would move companies towards lower tax brackets thereby saving taxes. This paper through agency theory looks at evaluating the reason why some companies through intercompany expense transfer lower their profits. This will be followed by analyzing the same through agency theory as to why other companies don’t reduce the profits and bring forward the actual and correct figures. The paper will then analyze the manner in which legitimacy theory will encourage companies performing in Australia to pay their taxes in Australia. This will help to solve the issues which ATO is facing and would bring forward the correct and true value of the organization. The report would thereby act as a guide and help the users to understand the manner in which different theory can help to take correct decisions. Agency Theory Agency theory looks at identifying the manner in which relationship between different parties are established so that better coordination can be achieved. The theory states that the principal or the owner looks at hiring an agent who will carry out the operations which the principal agent is unable to carry out (Jensen & Clifford, 2005). In case of multinational companies the principal owner is unable to carry out operations due to which subsidiaries are created. The subsidiaries carry out operations on behalf of the principal owner. It is mandatory that the agent carries out activities which are in the interest of the principal owner. It is the duty of the agent to ensure that the interest of the owner is protected all time and decisions are taken which helps to ensure that the principal owner gains. This has resulted in certain organizations who are subsidiaries of the principal organizations have started to increase the inter transfer expenses thereby resulting in the decrease in profits. For example Haier which is working in Australia is a China based company and has looked towards reducing its profits so that the parent company can earn higher profits. Organizations have used the agency theory where they have used it as a mechanism to reduce profits so that principal organizations gain. Some of the reason which has led towards organizations to reduce the profits so that principal owner gains are as Firstly, the agent under the mechanism of agency theory has looked towards protecting the interest of the principal provider. The agency theory states that the interest of the principal owner should be protected. The agent has looked towards working in the same direction and has followed the different guidelines which are provided by the theory. This will help the agent to ensure that all decisions which are taken protect the interest of the principal owner. This is one of the reasons which have looked towards agent to work in favour of the principal owner (Murphy, 2005). Since, both the parties i.e. agent and principal are motivated towards protecting towards the interest of the principal owner so that agent has acted fair in ensuring that profits are shown to the minimum level possible so that the principal owner gains. The agent as a result to ensure that the gains for the principal owner are maximized has used intercompany transfers which have resulted in reducing the profits. The profits are instead transfer to the principal provider as the major objective of the principal is to maximize profits. The agent has thereby looked at fulfilling the different promises which are made to the owner and has taken steps and decisions which maximizes the same. Secondly, both the agent and the principal owner have the same objective which is to maximize the profits. Since both of them have the same common interest and the principal knows the consequences of the different activities which are undertaken by the agent it has helped the principal to ascertain the profits more accurately. This forces the agent to take decisions which are fair and correct from the principal point of view (Rozeff, 2002). Apart from it the agent is paid for the services which the agent provides so it is the responsibility of the agent to protect the interest of the principal provider. Since, both the parties i.e. agent and principal are motivated towards protecting towards the interest of the principal owner so that agent has acted fair in ensuring that profits are shown to the minimum level possible so that the principal owner gains (Tony & Kerry, 2009). The process has resulted in the agent ensuring higher profits for the principal provider and lower profits for the subsidiaries. The agent has a responsibility to act in favour of the principal provider as the agent is adequately compensated for the different activities carried out by them. Since, there is a mutual understanding between the agent and the principal and both have a similar objective so acting in favour of the principal is the prime task which the agent should undertake which has resulted in lower profits for the subsidiaries. Despite the fact that multinational companies have adopted a strategy where profits for subsidiaries are reduced and principal provider maximizes the same, it is seen that certain organization instead look towards having high profits. This is a case for most organization who work in Australia and also for some multinational which looks to work on the different concept of agency theory (Corfield, 1998). For example Woolworth which is an Australian based company has ensured that they highlight the correct profits and have not looked towards manipulating their books so that different profits are shown. Some of the reasons which can be attributed to the fact that higher profits are shown are as Firstly, organizations which are performing in Australia have looked towards ensuring that the interest of the shareholders is protected. The organization has looked at ensuring that the correct profits which the business has earned after performing in Australia is shown so that the interest of the shareholders is protected. The agency theory requires that the agent acts in interest of the principal owner (Jacobs, 2006). Since organizations working in Australia itself has a moral responsibility of protecting the interest of the principal owner i.e. the shareholders they have highlighted the correct profits. In addition to it the agent or the principal provider has to ensure that profits are maximized so the organization has looked towards taking steps where they show the correct profits. As a result the profits which are highlighted in the books are shown correctly. The theory would help the organization to provide actual and correct values which would thereby guide help to ensure that all decisions which are taken are as per the things provided in the agency theory. Secondly, organizations working in Australia have the moral responsibility to ensure that they highlight the correct profits so that correct taxes are paid. It is imperative that organizations pay taxes correctly as it is the responsibility to ensure that the shareholders are protected. Organizations performing in Australia needs to contribute towards the society which they do through the process of taxation. Highlighting the correct profits thereby helps to take a big step in that direction. The organization by being fair and morally correct thereby looks towards highlighting the correct profits and ensure that they pay the adequate taxes (Easterbrook, 2004). The agency theory also advocates the fact that fairness should be maintained so by highlighting the correct profits correct steps are taken to act fairly. This will ensure that correct information is provided to the users and would act as a step towards corporate governance. The process would help the business to take decisions considering the larger section in mind which would thereby result in bringing forward the actual and correct values. Since, the organization is working in Australia and they are committed towards the people of Australia so taking the correct step and highlighting the correct profits would help to ensure better adherence to the different governance requirements. Legitimacy Theory ATO has stated that legitimacy theory should be adopted by organizations as it will help the business to act fairly and would thereby bring forward the correct profits. Legitimacy theory states that actions of an entity would be deemed desirable if they are carried out with certain specific norms and beliefs (Ashford and Gibbs, 1990). This would ensure that agents who look to work towards the interest of the principal provider would look to undergo the required changes. The theory would force the agent to ensure that correct profits from the working in Australia are highlighted as the different resources of Australia would be used to generate revenues. This would make the entity to understand the fact that they need to take steps which are desirable as it would require taking steps through which the stakeholders are protected (Mobus, 2005). The theory would entail the subsidiary unit to understand that the steps which are undertaken by them are in the interest of majority which would help to bring forward the correct profits which the subsidiary has earned. The theory would also help to ensure that the subsidiary understands the bigger framework and looks at protecting the interest of people thereby ensuring that the correct profits are shown. Conclusion This paper shows the manner in which agency theory evaluates the reason why some companies through intercompany expense transfer lower their profits. This is followed by analyzing the same through agency theory as to why other companies don’t reduce the profits and bring forward the actual and correct figures. The paper then analyzes the manner in which legitimacy theory will encourage companies performing in Australia to pay their taxes in Australia. This has helped to solve the issues which ATO is facing and would bring forward the correct and true value of the organization. The report thereby acts as a guide and helps the users to understand the manner in which different theory can help to take correct decisions. References Ashford, B. E. and Gibbs, B. W. 1990. The Double-Edge of Organizational Legitimation. Organization Science, 1 (2), 177 - 194. Corfield, A. 1998. The Stakeholder Theory and its Future in Australian Corporate Governance. Bond Law Review, 10 (2), 213 Easterbrook, H. 2004. Two Agency-Cost Explanations of Dividends. American Economic Review, 74, 650-59 Jacobs, E. 2006. The Agency Cost of Corporate Control: The Petroleum Industry. Massachusetts Institute of Technology Jensen, M. & Clifford S. 2005. Stockholder, Manager and Creditor Interests: Applications of Agency Theory. Recent Advances in Corporate Finance. E. I. Altman and M. G. Subrahmanyam. Homewood, Illinois, Irwin: 93-131 Murphy, J. 2005. Corporate Performance and Managerial Remuneration: An Empirical Analysis. Journal of Accounting and Economics, 7, 11-42. Mobus, J. 2005. andatory environment disclosures in a legitimacy theory context. Accounting, Auditing & Accountability Journal, 18 (4), 492-517 Rozeff, M. 2002. Growth, Beta and Agency Costs as Determinants of Dividend Payout Ratios. Journal of Financial Research, 5, 249-259 Tony, N. & Kerry, H. 2009. The stakeholder theory in the modern global business environment. International Journal of Applied Institution Governance, 1 (1), 3 Read More