Debt shifting in response to international tax incentives : Evidence from European multinational corporations

Abstract

This study examines whether national and international tax factors can explain leverage decisions of European multinational corporations. Using the model specification proposed by Møen, Schindler, Schjelderup and Tropina (2011), the study predicts that an affiliate’s leverage depends on host country statutory corporate tax rate and differences between host country tax rate and foreign tax rates. Differences in international tax rates influence international debt shifting whose main idea is claiming interest income in low-tax countries and interest expenses in high-tax countries. Predictions of the model form the basis of my main research question and sub-questions, which are tested on a data sample of European multinational firms and their majority-owned subsidiaries, obtained from firmlevel Amadeus database. Historical ownership data on majority-owned subsidiaries of European multinational firms is initially obtained from firm-level Orbis database. The obtained results show that an affiliate’s financial structure depends on three tax mechanisms: host country corporate tax rate, external debt shifting mechanism and internal debt shifting mechanism. Due to correlation between the tax mechanisms, omission of any of them from the specification would bias the estimated effect on affiliate’s leverage of the other tax mechanisms that are included in the specification. Assuming a constant historical ownership structure over the sample period would result in misclassified subsidiary-parent relations and a subsequent downward bias in the estimated effect of international debt shifting mechanisms on affiliate’s leverage. Hence, adjustments to historical ownership structure changes are necessary to obtain unbiased estimates of variables that are measured based on data on all affiliates within the multinational group. Finally, European multinational corporations with majority-owned affiliates outside Europe must also be considered carefully. Capital structures of European affiliates which belong to these multinational corporations seem to be less responsive to international tax incentives. This finding can be explained by measurement errors in the international debt shifting mechanisms that arise due to disregarding financial and tax data on affiliates outside Europe that belong to the multinational group.