Research in Finance Series: Corporate Finance
“Taxes and Leverage at Multinational Corporations”
by Professor Michael Faulkender
Director of the Masters Program in Finance
Robert H. Smith School of Business, University of Maryland
Michael Faulkender’s research focuses on empirical corporate finance in the areas of capital structure, risk management, corporate liquidity, and executive compensation. His work has been published in the Journal of Finance, Journal of Financial Economics, and Review of Financial Studies and has been cited in the Wall Street Journal, Washington Post, and The New York Times. He was awarded the Barclay’s Global Investors / Michael Brennan Best Paper Award in the Review of Financial Studies in 2013, was runner up for that prize in 2006, and won the Jensen Prize for Corporate Finance – Second Prize in the Journal of Financial Economics in 2013
Abstract: Empirical research has struggled to document the variation in recent corporate capital structures as arising from variation in estimated corporate income tax rates. We argue that in previous studies, both the tax rates applied to multinational corporations and the taxable income earned has been mismeasured, a result of firms operating in many foreign countries. Using a sample of multinational firms collected in the Bureau of Economic Analysis’ annual survey combined with each firm’s respective income and country specific tax rate, we revisit this tax-leverage puzzle. Empirically we find that firms do have higher leverage ratios and lower interest coverage ratios when they operate in countries with higher tax rates, as theory would suggest. Our results demonstrate that the primary benefit of leverage under the trade-off theory of capital structure continues to have empirical support.