Tunneling Through Group Trademarks

A trademark is a type of intellectual property comprising a recognizable word, phrase, symbol, and/or design that distinguishes products or services of a particular source from those of others. If registered, the trademark owner obtains exclusive rights to operate and market under the trademark. By entering into a licensing agreement with another party (the licensee), the trademark owner (the licensor) can receive royalties in return for allowing the other party to commercially use the trademark.

However, if the licensor and the licensee are related parties, the agreement may not be a result of arm’s length negotiation. It is possible for one member to influence another with respect to the pricing of royalty rates. They could agree upon a rate that is different from the one that would have been agreed between two independent entities acting to maximize their economic returns from the transaction. A good example is trademark transfer pricing—that is, establishing a mechanism within multinational groups to move trademark-related profits from high tax jurisdictions to low/no jurisdictions.

In this study, we introduce another example, where family-controlled business groups establish a mechanism to move trademark-related profits from firms with low family ownership to firms with high family ownership. In other words, we study how group trademarks, comprising the business group’s name and logo, are used to benefit controlling family members at the expense of outside minority shareholders.

As in other tunneling studies, the greatest challenge is discerning whether the terms applied to trademark transactions are fair or not. We follow the practice in the existing literature and provide indirect evidence. That is, predicting the pattern of intragroup trademark transactions in the presence of tunneling and finding evidence that is consistent with these predictions. Like in many other tunneling studies, we make predictions by making use of the cash flow rights the controlling family holds in each member firm.

Using a sample of 34 family-controlled business groups that charged group trademark royalties in 2017, we find evidence consistent with the presence of tunneling. First, we find that trademarks tend to be owned by firms wherein the controlling family holds high cash flow rights.

Second, we find that firms with larger sales volume are more likely to be licensee firms and that this likelihood increases further as the controlling family’s cash flow rights in such firms fall further below those in the licensor firms.

Third, we find that trademark royalty rates rise with the sales volume of the licensee firms only if the controlling family’s cash flow rights in such firms are far below those in the licensor firms.

Fourth, we explore the main concern to outside minority shareholders that hold the shares of licensee firms—that is, the consequence of trademark royalty payments by licensee firms on their dividend payouts to shareholders. We find that dividend payouts are negatively associated with royalty payments in firms where the controlling family’s cash flow rights in such firms are far below those in the licensor firms.

Fifth, we find that the dividend payouts and trademark royalty payments of licensee firms increase with their sales volume, but the former increase less and the latter more if the controlling family’s cash flow rights in the licensee firms are far below those in the licensor firms.