Thin Capitalization Rules and Multinational Firm Capital Structure

CentER Discussion Paper Series No. 2014-007

48 Pages Posted: 16 Jan 2014

See all articles by Jennifer Blouin

Jennifer Blouin

University of Pennsylvania - Accounting Department

Harry Huizinga

Tilburg University - Center for Economic Research (CentER); Centre for Economic Policy Research (CEPR)

Luc Laeven

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Gaëtan Nicodème

Université Libre de Bruxelles (ULB) - Solvay Brussels School of Economics and Management; CEPR and CESifo The views expressed in the article are those of the author and should not be attributed to the European Commission.

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Date Written: January 15, 2014

Abstract

This paper examines the impact of thin capitalization rules that limit the tax deductibility of interest on the capital structure of the foreign affiliates of US multinationals. We construct a new data set on thin capitalization rules in 54 countries for the period 1982-2004. Using confidential data on the internal and total leverage of foreign affiliates of US multinationals, we find that thin capitalization rules affect multinational firm capital structure in a significant way. Specifically, restrictions on an affiliate’s debt-to-assets ratio reduce this ratio on average by 1.9%, while restrictions on an affiliate’s borrowing from the parent-to-equity ratio reduce this ratio by 6.3%. Also, restrictions on borrowing from the parent reduce the affiliate’s debt to assets ratio by 0.8%, which shows that rules targeting internal leverage have an indirect effect on the overall indebtedness of affiliate firms. The impact of capitalization rules on affiliate leverage is higher if their application is automatic rather than discretionary. Furthermore, we show that thin capitalization regimes have aggregate firm effects: they reduce the firm’s aggregate interest expense bill but lower firm valuation. Overall, our results show than thin capitalization rules, which thus far have been understudied, have a substantial effect on the capital structure within multinational firms, with implications for the firm’s market valuation.

Keywords: Thin capitalization rule; Multinational firm; Capital structure; Taxation

JEL Classification: G32, H25

Suggested Citation

Blouin, Jennifer and Huizinga, Harry and Laeven, Luc A. and Nicodeme, Gaetan, Thin Capitalization Rules and Multinational Firm Capital Structure (January 15, 2014). CentER Discussion Paper Series No. 2014-007, Available at SSRN: https://ssrn.com/abstract=2379467 or http://dx.doi.org/10.2139/ssrn.2379467

Jennifer Blouin (Contact Author)

University of Pennsylvania - Accounting Department ( email )

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Harry Huizinga

Tilburg University - Center for Economic Research (CentER) ( email )

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Centre for Economic Policy Research (CEPR)

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Luc A. Laeven

European Central Bank (ECB) ( email )

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Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Gaetan Nicodeme

Université Libre de Bruxelles (ULB) - Solvay Brussels School of Economics and Management ( email )

50 Avenue Roosevelt
Brussels 1050
Belgium

CEPR and CESifo The views expressed in the article are those of the author and should not be attributed to the European Commission.

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