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Multinational Financial Policy and the Cost of Capital: The Many Roads Home

  • Rosanne Altshuler

    ()

    (Rutgers University, Department of Economics)

  • Harry Grubert

    ()

    (U.S. Treasury Department)

The previous literature on multinational financial policy has, for the most part, been restricted to the choice between dividend distributions to the parent and further real investment in the foreign affiliate. We argue that investment in financial assets such as the debt and equity of related affiliates or Eurodollar deposits, for example, offer multinationals attractive alternatives to dividend repatriation. We present theoretical models that illustrate how investment and financial incentives change when the possibility of investing in financial assets is added to the analysis. Our models depart from previous work in several important ways. We drop the standard arbitrage condition in which equity and debt are perfect substitutes from the viewpoint of the firm and instead impose a worldwide financial constraint consistent with a rising cost of debt finance. In our models, parents can borrow against financial assets held abroad and may allocate debt across locations to achieve the lowest cost of capital at home and abroad. We also consider the implications of models in which affiliates can invest in related affiliates in other foreign countries. We use firm level balance sheet data from controlled foreign corporations (CFCs) available in the Treasury tax files to test the implications of our models. Our regression results confirm the importance of tax considerations in explaining CFC holdings of financial assets. We also find that CFCs with more debt distribute more dividends. This provides evidence that greater dividend distributions do not necessarily imply lower real investment by CFCs.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 199807.

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Date of creation: 29 Mar 1998
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Handle: RePEc:rut:rutres:199807
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  1. James R. Hines, Jr. & Eric M. Rice, 1990. "Fiscal Paradise: Foreign Tax Havens and American Business," NBER Working Papers 3477, National Bureau of Economic Research, Inc.
  2. Sinn, Hans-Werner, 1984. "Die Bedeutung des Accelerated Cost Recovery System fur den internationalen Kapitalverkehr. (The Significance of the Accelerated Cost Recovery System for International Capital Movements. With English s," Kyklos, Wiley Blackwell, vol. 37(4), pages 542-76.
  3. Hines, J.R.J. & Hubbard, R.G., 1989. "Coming Home To America - Devidend Repatriations By U.S. Multinationals," Papers 146, Princeton, Woodrow Wilson School - Public and International Affairs.
  4. Assaf Razin & Joel Slemrod, 1990. "Taxation in the Global Economy," NBER Books, National Bureau of Economic Research, Inc, number razi90-1.
  5. Sinn, H.W., 1990. "Taxation And The Birth Of Foreign Subsidiaries," Papers 66, Princeton, Woodrow Wilson School - Discussion Paper.
  6. Hugh J. Ault & David F. Bradford, 1990. "Taxing International Income: An Analysis of the U.S. System and Its Economic Premises," NBER Chapters, in: Taxation in the Global Economy, pages 11-52 National Bureau of Economic Research, Inc.
  7. Altshuler, R. & Newlon, T.S., 1991. "The Effects of US Tax Policy on the Income Repatriation Patterns of US Multinational Corporations," Discussion Papers 1991_60, Columbia University, Department of Economics.
  8. Rosanne Altshuler & Jack Mintz, 1995. "U.S. interest-allocation rules: Effects and policy," International Tax and Public Finance, Springer, vol. 2(1), pages 7-35, February.
  9. Kenneth A. Froot & James R. Hines, Jr., 1995. "Interest Allocation Rules, Financing Patterns, and the Operations of U.S. Multinationals," NBER Chapters, in: The Effects of Taxation on Multinational Corporations, pages 277-312 National Bureau of Economic Research, Inc.
  10. Hartman, David G., 1985. "Tax policy and foreign direct investment," Journal of Public Economics, Elsevier, vol. 26(1), pages 107-121, February.
  11. Alfons Weichenrieder, 1996. "Anti-tax-avoidance provisions and the size of foreign direct investment," International Tax and Public Finance, Springer, vol. 3(1), pages 67-81, January.
  12. Rosanne Altshuler, 1995. "Do Repatriation Taxes Matter? Evidence from the Tax Returns of U.S. Multinationals," NBER Chapters, in: The Effects of Taxation on Multinational Corporations, pages 253-276 National Bureau of Economic Research, Inc.
  13. James R. Hines Jr., 1992. "Credit and Deferral as International Investment Incentives," NBER Working Papers 4191, National Bureau of Economic Research, Inc.
  14. Horst, Thomas, 1977. "American Taxation of Multinational Firms," American Economic Review, American Economic Association, vol. 67(3), pages 376-89, June.
  15. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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