This paper examines the impact of local tax rates and capital market conditions on the level and composition of borrowing by foreign affiliates of American multinational corporations. The evidence indicates that 10 percent higher local tax rates are associated with 2.8 percent higher debt/asset ratios of American-owned affiliates, and that borrowing from related parties is particularly sensitive to tax rates. Borrowing by American affiliates responds to local inflation and political risks, and is more costly in countries with underdeveloped capital markets and those providing weak legal protections for creditors. Affiliates in environments where external borrowing is costly borrow less from unrelated parties: one percent higher interest rates are associated with 1.4 to 2.0 percent less external debt as a fraction of assets. Instrumental variables analysis reveals that affiliates substitute loans from parent companies for between half and three quarters of the reduced borrowing from unrelated parties stemming from adverse local capital market conditions. These patterns suggest that multinational firms are able to structure their finances in response to tax and capital market conditions, thereby creating opportunities not available to many of their local competitors. IntroductionTo what extent does corporate borrowing increase due to the tax deductibility of interest expenses and decline in response to costs imposed by capital market underdevelopment or unfavorable legal systems? Do firms use internal capital markets to substitute for external finance when the latter is costly, and if so, how extensive is such substitution? Empirical attempts to answer these fundamental questions face significant challenges. Limited variation in tax incentives within countries makes it difficult to identify the effects of taxes, and detailed information on the workings of internal capital markets is scarce. Recent efforts using cross-country samples exploit the rich variation that international comparisons offer, but frequently face problems associated with nonstandardized measurement across countries and limited statistical power due to small sample sizes.Cross-country studies of capital structure commonly ignore the many wrinkles associated with multinational firms. These firms face differing tax incentives and legal regimes around the world, making it possible to identify the impact of these factors on financing choices. Analysis of the behavior of multinational firms promises clean estimates of the sensitivity of capital structure choice to tax incentives, an understanding of the mechanisms by which weak capital markets alter financing choices, and insight into the ways in which internal capital markets can facilitate tax minimization and provide an alternate financing source when external financing is most costly.This paper analyzes determinants of the capital structures of foreign affiliates of U.S.multinational firms. The use of confidential affiliate-level data makes it possible to distinguish the behavior of fore...
This paper analyzes the financing terms that support international trade and sheds light on how and why these arrangements affect trade. Using detailed transaction level data from a U.S. based exporter of frozen and refrigerated food products, primarily poultry, it begins by describing broad patterns about the use of alternative financing terms. These patterns help discipline a model in which the trade finance mode is shaped by the risk that an importer defaults on an exporter and by the possibility that an exporter does not deliver goods as specified in the contract. The empirical results indicate that transactions are more likely to occur on cash in advance or letter of credit terms when the importer is located in a country with weak contractual enforcement and in a country that is further from the exporter. Letters of credit, however, are rarely used by the exporter. As an importer develops a relationship with the exporter, transactions are less likely to occur on terms that require prepayment. During the recent crisis, the exporter was more likely to demand cash in advance terms when transacting with new customers, and customers that traded on cash in advance terms prior to the crisis disproportionately reduced their purchases. These results can be rationalized by the model whenever (i) misbehavior on the part of the exporter is of little concern to importers, and (ii) local banks in importing countries are typically more effective than the exporter in pursuing financial claims against importers.
This paper examines the impact of local tax rates and capital market conditions on the level and composition of borrowing by foreign affiliates of American multinational corporations. The evidence indicates that 10 percent higher local tax rates are associated with 2.8 percent higher debt/asset ratios of American-owned affiliates, and that borrowing from related parties is particularly sensitive to tax rates. Borrowing by American affiliates responds to local inflation and political risks, and is more costly in countries with underdeveloped capital markets and those providing weak legal protections for creditors. Affiliates in environments where external borrowing is costly borrow less from unrelated parties: one percent higher interest rates are associated with 1.4 to 2.0 percent less external debt as a fraction of assets. Instrumental variables analysis reveals that affiliates substitute loans from parent companies for between half and three quarters of the reduced borrowing from unrelated parties stemming from adverse local capital market conditions. These patterns suggest that multinational firms are able to structure their finances in response to tax and capital market conditions, thereby creating opportunities not available to many of their local competitors. IntroductionTo what extent does corporate borrowing increase due to the tax deductibility of interest expenses and decline in response to costs imposed by capital market underdevelopment or unfavorable legal systems? Do firms use internal capital markets to substitute for external finance when the latter is costly, and if so, how extensive is such substitution? Empirical attempts to answer these fundamental questions face significant challenges. Limited variation in tax incentives within countries makes it difficult to identify the effects of taxes, and detailed information on the workings of internal capital markets is scarce. Recent efforts using cross-country samples exploit the rich variation that international comparisons offer, but frequently face problems associated with nonstandardized measurement across countries and limited statistical power due to small sample sizes.Cross-country studies of capital structure commonly ignore the many wrinkles associated with multinational firms. These firms face differing tax incentives and legal regimes around the world, making it possible to identify the impact of these factors on financing choices. Analysis of the behavior of multinational firms promises clean estimates of the sensitivity of capital structure choice to tax incentives, an understanding of the mechanisms by which weak capital markets alter financing choices, and insight into the ways in which internal capital markets can facilitate tax minimization and provide an alternate financing source when external financing is most costly.This paper analyzes determinants of the capital structures of foreign affiliates of U.S.multinational firms. The use of confidential affiliate-level data makes it possible to distinguish the behavior of fore...
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