Investor Valuations of Japan's Adoption of a Territorial Tax Regime: Quantifying the Direct and Competitive Effects of International Tax Reform

Despite an extensive literature on the normative implications of different international tax regimes and an empirical literature addressing individual specific predictions, there exists little evidence encompassing the broad range of effects of taxing corporations' foreign-source income on a worldwide or territorial basis. This paper takes a more comprehensive quantitative approach by examining stock market reactions surrounding three events over the course of which Japan's 2009 adoption of a dividend exemption system was developed into proposed law. Using an event study methodology which leverages individual firm characteristics and accounts for contemporaneous financial market developments, we find that Japanese firms with less foreign exposure and fewer opportunities for tax avoidance experienced relatively larger abnormal returns, while differences in firms' foreign and domestic effective tax rates accounted for an aggregate capitalization effect of 4.1 trillion JPY. We attribute these gains to a combination of enhanced opportunities for international expansion among smaller domestic firms, direct tax savings on official estimates of existing undistributed foreign earnings, and general cultural biases against tax planning in an environment of largely unchanged anti-abuse provisions. Spillover effects in the U.S. and German markets (through tax competition or firm competitiveness) appear insignificant.