A Multinational Perspective on Capital Structure Choice and Internal Capital Markets

44 Pages Posted: 9 May 2003  

Mihir A. Desai

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

C. Fritz Foley

Harvard Business School; National Bureau of Economic Research (NBER)

James R. Hines Jr.

University of Michigan; NBER

Multiple version iconThere are 2 versions of this paper

Date Written: May 2003

Abstract

This paper examines the impact of local tax rates and capital market conditions on the level and composition of borrowing by foreign affiliates of American multinational corporations. The evidence indicates that 10 percent higher local tax rates are associated with 2.8 percent higher debt/asset ratios of American-owned affiliates, and that borrowing from related parties is particularly sensitive to tax rates. Borrowing by American affiliates responds to local inflation and political risks, and is more costly in countries with underdeveloped capital markets and those providing weak legal protections for creditors. Affiliates in environments where external borrowing is costly borrow less from unrelated parties: One percent higher interest rates are associated with 1.4 to 2.0 percent less external debt as a fraction of assets. Instrumental variables analysis reveals that affiliates substitute loans from parent companies for between half and three quarters of the reduced borrowing from unrelated parties stemming from adverse local capital market conditions. These patterns suggest that multinational firms are able to structure their finances in response to tax and capital market conditions, thereby creating opportunities not available to many of their local competitors.

Keywords: Multinational, Capital Structure, Internal Capital Markets, Legal Regime, Law and Finance, Corporate Tax

JEL Classification: G32, H25, G38, F23

Suggested Citation

Desai, Mihir A. and Foley, C. Fritz and Hines Jr., James R., A Multinational Perspective on Capital Structure Choice and Internal Capital Markets (May 2003). Harvard NOM Working Paper No. 03-27. Available at SSRN: https://ssrn.com/abstract=405023 or http://dx.doi.org/10.2139/ssrn.405023

Mihir A. Desai (Contact Author)

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C. Fritz Foley

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James Rodger Hines

University of Michigan ( email )

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NBER

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