Tax Shelters and Corporate Inversions

Paper Session

Saturday, Jan. 7, 2017 8:00 AM – 10:00 AM

Sheraton Grand Chicago, Mayfair
Hosted By: Association of Financial Economists & American Finance Association
  • Chair: Kose John, New York University and Temple University

The Effect of Inversions on Corporate Governance

Felipe Cortes
,
Northeastern University
Armando Gomes
,
Washington University-St. Louis
Radhakrishnan Gopalan
,
Washington University-St. Louis

Abstract

The race by American companies to change their incorporation to countries with a lower corporate tax rate (inversion) has reached fever pitch. An open empirical question is if and how such an inversion affects a firm's governance. While many inversions happen to countries that offer weaker protection to minority shareholders than the U.S., we find that most firms that invert continue to be treated by the SEC as an “U.S. issuer”, and thus their shareholders benefit from the full protection offered by the U.S. Federal Securities Laws. Our analysis shows that executives in inverted firms receive more cash compensation and their wealth is less sensitive to stock prices. After an inversion, firms increase the number of anti-takeover charter provisions. Consistent with weaker market-based governance, the stock price of firms that invert is less liquid and the firms have lower institutional ownership. Investors put a lower value on the cash on inverted firm's balance sheet especially if the firm inverts to a country that ranks low in terms of rule of law. Overall, our results highlight that despite enjoying the full protection of U.S. Federal Securities Laws, inverted firms have weaker governance relative to comparable U.S. firms.

What Drives Corporate Inversions? International Evidence

Burcin Col
,
Pace University
Rose Liao
,
Rutgers University
Stefan Zeume
,
University of Michigan

Abstract

Using hand-collected data on 691 corporate inversions from 11 home countries into 45 host countries over the last two decades, we document that countries attract inversions by offering low tax rates and strong governance standards. Indeed, passage of bilateral Double Taxation Treaties (DTTs), which provide additional tax incentives for inversions, is associated with an increase in corporate inversions. Similarly, passage of bilateral Tax Information Exchange Agreements (TIEAs), which improve transparency of tax havens, is associated with an increase in corporate inversions. Further, shareholders applaud tax-driven inversions but shun inversions into weakly governed countries. A 1% point lower tax rate in the host country (vis-à-vis the home country) is associated with a 0.6% drop in effective tax rates and a 0.4% increase in firm value. Firms inverting into tax havens reduce their effective tax rate by 5.4% points subsequent to the inversion. Institutional ownership increases when firms invert into well-governed countries but declines when firms invert into weakly governed countries. Taken together, this paper sheds light on tax and governance motives as drivers of international inversions.

Debt, Bankruptcy Risk, and Corporate Tax Sheltering

Akanksha Jalan
,
Indian Institute of Management Bangalor
Jayant Kale
,
Northeastern University
Costanza Meneghetti
,
West Virginia University

Abstract

We examine the effect of leverage and bankruptcy risk on corporate incentives to shelter income from taxes. We derive the optimal level of sheltering for a levered firm in a two-date, single-period model in which a firm’s perquisite-consuming manager with an equity stake in the firm maximizes her payoff. The theory predicts that sheltering relates negatively to leverage, monitoring, and manager’s bankruptcy costs; and positively to the manager’s equity stake in the firm. The theory also predicts that the negative relation between leverage and sheltering becomes weaker as the manager’s equity stake increases. Our empirical tests provide evidence that is consistent with these theoretical predictions. Leverage and bankruptcy risk relate negatively to sheltering whereas greater managerial ownership increases sheltering and also weakens the negative sheltering-leverage relation. Further, we show that the negative effects of bankruptcy risk and debt on sheltering are stronger for riskier firms; and weaker for larger, better governed, more profitable firms, and for firms that are in the “public eye”. Our results are robust to endogeneity concerns.

Are Corporate Inversions Good for Shareholders?

Anton Babkin
,
University of Wisconsin-Madison
Brent Glover
,
Carnegie Mellon University
Oliver Levine
,
University of Wisconsin-Madison

Abstract

In 2014 alone, U.S. firms worth over half a trillion dollars announced their intention to expatriate to a foreign country---a corporate inversion---in order to reduce corporate income taxes. To discourage expatriation, U.S. law requires shareholders of inverting firms to realize a personal capital gains tax liability at the completion of the transaction. Thus, while reduced corporate taxes benefit all shareholders equally, a corporate inversion results in a personal tax cost that depends on the individual investor's tax basis and standing. We develop a model to value the net benefits of inversion and we show that private returns to investors vary widely across individuals. We find that the benefits of inversion disproportionately accrue to the CEO, foreign shareholders, and short-term investors, while many long-term investors suffer a net loss.
Discussant(s)
Dalida Kadyrzhanova
,
Georgia State University
Kimberly Cornaggia
,
Pennsylvania State University
S. Abraham Ravid
,
Yeshiva University
Michael Faulkender
,
University of Maryland
JEL Classifications
  • G3 - Corporate Finance and Governance
  • H2 - Taxation, Subsidies, and Revenue