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Schindler, Dirk; Møen, Jarle; Schjelderup, Guttorm; Tropina, Julia
International Debt Shifting: Do Multinationals Shift
Internal or External Debt?
Beiträge zur Jahrestagung des Vereins für Socialpolitik 2013: Wettbewerbspolitik und
Regulierung in einer globalen Wirtschaftsordnung - Session: Taxation of Multinationals, No.
Provided in Cooperation with:
Verein für Socialpolitik / German Economic Association
Suggested Citation: Schindler, Dirk; Møen, Jarle; Schjelderup, Guttorm; Tropina, Julia (2013) :
International Debt Shifting: Do Multinationals Shift Internal or External Debt?, Beiträge zur Jahrestagung des Vereins für Socialpolitik 2013: Wettbewerbspolitik und Regulierung in einer globalen Wirtschaftsordnung - Session: Taxation of Multinationals, No. D06-V2
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zbw Leibniz-Informationszentrum Wirtschaft Leibniz Information Centre for Economics
International Debt Shifting:
∗ Do Multination
March 05, 2012 Abstract Multinational companies can exploit the tax advantage of debt more aggressively than national companies. Besides utilizing the standard debt tax shield, multinationals can shift debt from aﬃliates in low-tax countries to aﬃliates in high-tax countries. We study the capital structure of multinationals and expand previous theory by incorporating debt tax shield eﬀects from both internal and external capital markets. A main ﬁnding is that ﬁrm value is maximized if both internal and external debt is used, and that internal lending should be conducted through a ﬁnancial center in the lowest taxed aﬃliate. Testing our model using a large panel of German multinationals, we identify all three debt tax shields. Our estimates suggest that internal and external debt shifting are of about equal relevance.
Keywords: Corporate taxation, multinationals, capital structure, international debt-shifting, tax avoidance JEL classiﬁcation: H25, G32, F23 ∗ We are grateful to Carsten Bienz, Roger Gordon, Heinz Herrmann, Harry Huizinga, Erling Røed Larsen, Tore Leite, Martin Ruf, Georg Wamser, and Alfons Weichenrieder as well as to participants at the annual conference of the Western Economic Association International in Portland, the Norwegian Research Forum on Taxation in Moss, and to participants at seminars in Bergen, Oslo and Tilburg for very helpful suggestions. Special thanks go to the people at Deutsche Bundesbank, in particular to Alexander Lipponer, for their invaluable support and for the hospitality of their research center. Remaining errors are ours. Financial support from the Research Council of Norway and the Deutsche Forschungsgemeinschaft is gratefully appreciated.
† Department of Finance and Management Science, Norwegian School of Economics: firstname.lastname@example.org.
‡ Department of Economics, Universit¨t Konstanz: email@example.com.
a § Corresponding author. Department of Finance and Management Science, Norwegian School of Economics, Helleveien 30, N-5045 Bergen, Norway. Email: firstname.lastname@example.org.
Department of Economics, Norwegian School of Economics: email@example.com.
1. Introduction It is well known that the debt tax shield is a key driver of both domestic and multinational companies’ capital structure. Multinational companies, however, can exploit the tax advantage of debt more aggressively than national companies by shifting debt from aﬃliates in low-tax countries to aﬃliates in high-tax countries. The value of such tax arbitrage must be balanced against other well-known costs and beneﬁts that inﬂuence the ﬁrm’s capital structure. Important non-tax factors include the use of debt as a disciplining device for overspending managers, and the need to balance indebtedness against the probability of costly bankruptcy.1 Several papers have documented that multinational corporations use international debt shifting as part of their ﬁnancial strategy, but they disagree on the mechanism. Huizinga et al. (2008) model the optimal allocation of external debt and ﬁnd that ignoring international debt shifting as part of the ﬁrm’s leverage decision understates the impact of national taxes on debt policies by about 25 %. Egger et al. (2010) model debt shifting by the use of internal debt and ﬁnd that multinationals have a signiﬁcantly higher debt-to-asset ratio than national ﬁrms, and that this diﬀerence is larger in high-tax countries.2 Both Huizinga et al. (2008) and Egger et al. (2010) use total debt, i.e., the sum of internal and external debt, in their empirical analyses. Because of this, the papers do not provide unambiguous empirical evidence in favor of their respective theory models.
In this paper, we use a theory model to derive the tax-eﬃcient capital structure of aﬃliates of multinational corporations. The model embeds all the well known costs and beneﬁts of using debt as described in the previous literature, but adds to previous theory by incorporating debt tax shield eﬀects from both internal and external capital markets. In particular, our model shows that there are three debt tax shield eﬀects that multinational companies can use; the standard debt tax shield eﬀect and two eﬀects related to international debt shifting.
The ﬁrst theoretical result to come out of our analysis is that ﬁrm value is maximized The various costs and beneﬁts of debt have recently been reexamined in empirical studies by van Binsbergen et al. (2010) and Korteweg (2010). They estimate that the net beneﬁts of debt amount to 5.5 % of ﬁrm value and 3.5 % of a ﬁrm’s book value, respectively.
Internal debt is also a topic in, e.g., Mintz and Weichenrieder (2010), B¨ttner et al. (2009) and in the u seminal paper by Desai et al. (2004).
when multinational companies’ shift both internal and external debt across international borders. Previous studies that omit one of the components, therefore, do not truly portrait proﬁt-maximizing behavior.
The model also predicts that the value of the ﬁrm is maximized if internal lending is conducted by a ﬁnancial center located in the country with the lowest eﬀective rate of tax.
As pointed out by Mintz and Smart (2004), this structure assures that interests earned are taxed with the lowest possible tax rate, while interests payed are deducted from taxable income in aﬃliates that face a higher tax rate. This reduces the global tax bill.3 Recently, Huizinga et al. (2008) have shown that external debt shifting matters when holding companies explicitly or implicitly guarantee to bail out aﬃliates facing bankruptcy.
In line with their analysis, we ﬁnd that the value of the external debt shield is maximized when multinational companies balance external debt across aﬃliates, taking into account the tax rate in all the countries where the group is present. An increase in the tax rate in one country will make it proﬁtable to use more debt in the aﬃliate located in this country.
More debt will, however, increase the risk of bankruptcy for the group. This eﬀect is mitigated by lowering the use of debt in all other aﬃliates. By shifting external debt this way, multinationals can exploit the debt tax shield to a greater extent than national ﬁrms, while holding the overall risk of bankruptcy in check.
The use of both internal and external debt is motivated by diﬀerences in national statutory tax rates in countries where aﬃliates are located. This implies that the tax variables that determine the incentive to shift internal and external debt are correlated both with each other and with the host country tax rate. A ﬁnal prediction that comes out of our theoretical analysis is therefore that empirical studies which omit either internal or external debt shifting suﬀer from an omitted variable bias.
We put our model to the test using a unique micro-level data set provided by Deutsche Bundesbank. The data set contains information on all German multinationals having at least one aﬃliate with more than three million euros in total assets. Contrary to other data sets, it contains information on external debt, and on internal debt from both parent companies and other aﬃliates within the group. Furthermore, our data set provides information about the An example of a company using this strategy is the Formula One business, where several highly internaldebt loaded ﬁrms under the umbrella of the Delta Topco Holding are paying 15 % interest to an internal bank located on the Channel Island Jersey which is well known as a tax haven. See Sylt and Reid (2011).
full ownership structure, that is, it allows for indirectly held ﬁrms and potential ownership chains. Our main sample consists of 33,857 ﬁrm-year observations of foreign aﬃliates of 3,660 German MNCs that form corporate groups having aﬃliates only in Europe (30 countries). In robustness tests, we also use extended samples, including up to 105,772 ﬁrm-year observations from 68 countries world-wide.
Our empirical analysis supports the predictions that follow from the model. Even though the three tax variables in the analysis are highly correlated by construction, we are able to identify the three tax shield mechanisms separately and with relatively high precision.
The economic importance of our estimated coeﬃcients can be illustrated by looking at a hypothetical case where a multinational group consists of two aﬃliates of equal size. If the aﬃliate located in the country with the highest tax rate experiences a 10 percentage points tax increase, the debt-to-asset ratio will fall by 1.4 percentage points in the low-tax country and increase by 4.6 percentage points in the high-tax country. For a company with an average debt-to-asset ratio at the outset, a 4.6 percentage points increase in the debt-to-asset ratio implies a 7.4 % increase in debt. About 40 % of the increase in debt is due to the tax induced advantage of debt that both national and multinational ﬁrms beneﬁt from, while about 60 % is due to international debt shifting. In the case of international debt shifting we ﬁnd that the shifting of internal and external debt is of about equal importance.
With respect to omitted variable bias, we ﬁnd that when the host country tax rate of an aﬃliate is the only tax variable in our regression, the estimation bias in the standard tax shield becomes about 140 % relative to our preferred estimate. This is the speciﬁcation one would use if not taking any kind of international debt shifting into account, and it would be suﬃcient for a sample of purely domestic ﬁrms.
Except for Huizinga et al. (2008), all previous papers neglect external debt shifting. In this case, the eﬀect of the standard debt tax shield that both national and multinational ﬁrms beneﬁt from, is overestimated by 100 % in our sample. The bias in the contribution of internal debt shifting is more modest, but with 40 %, still substantial. When internal debt is neglected in the estimations, as in Huizinga et al. (2008), the omitted variable bias is relatively modest; about 9 % for the standard debt tax shield and about 4 % for external debt shifting.