Factors of Credit Ratings for Transfer Pricing of Loans in European Conditions

Abstract

In accord with international transfer pricing regulations, the borrower’s creditworthiness is the main factor to be reflected in valuation of cross-border loan transactions between associated enterprises. However, trouble invariably arises for small and medium-sized enterprises that do not have an assigned credit rating. The aim of this paper is to determine the most reliable predictors of a company’s credit rating for European entities facing missing rating coverage for the purpose of transfer pricing. Based on 2015–2019 data sourced from the Orbis database, the study examines key financial ratios and non-financial information that could be instrumental in reconstructing a long-term rating category of a company assigned by Moody’s Investors Service. The results identify interest coverage as the most useful predictor. Therefore, a law-approved and tax-acceptable approach to pricing of financial transactions between unrated parties (i.e., without credit rating) should preferably exploit interest coverage as a link to the otherwise missing ratings.