The Location, Composition, and Investment Implications of Permanently Reinvested Earnings

Abstract

This study estimates the location, composition, and investment implications of permanently reinvested earnings (PRE) reported in U.S. multinational corporations’ (MNCs) consolidated financial statements. Our first set of analyses suggest that firms’ PRE designations are motivated by both financial reporting incentives (i.e., tax expense deferral) and investment opportunities. Our analyses suggest that PRE designations are driven in part by tax and growth incentives – 24 percent of PRE is located in affiliates residing in tax havens, and 39 percent of PRE is in high-growth affiliates. Furthermore, we find that a significant amount of PRE – 54 percent – is invested in financial assets.Our second set of analyses find that domestic investment by MNCs with PRE is less responsive to domestic investment opportunities and more sensitive to domestic cash flow than firms without PRE, consistent with PRE indicating internal capital market frictions. We conclude that financial statement users could benefit from enhanced disclosures about foreign operations.

Keywords: permanently reinvested earnings; repatriation tax; internal capital market efficiency