Thin Capitalization Rules and Multinational Firm Capital Structure

J. Blouin, H.P. Huizinga, L. Laeven, G. Nicodeme

Research output: Working paperDiscussion paperOther research output

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Abstract

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.
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages48
Volume2014-007
Publication statusPublished - 2014

Publication series

NameCentER Discussion Paper
Volume2014-007

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Capitalization
Multinational firms
Capital structure
Leverage
Borrowing
Multinationals
Debt
Assets
Foreign affiliates
Firm effects
Equity
Firm valuation
Indebtedness
Tax
Targeting rules
Expenses
Indirect effects
Market valuation

Keywords

  • Thin capitalization rule
  • Multinational firm
  • Capital structure
  • Taxation

Cite this

Blouin, J., Huizinga, H. P., Laeven, L., & Nicodeme, G. (2014). Thin Capitalization Rules and Multinational Firm Capital Structure. (CentER Discussion Paper; Vol. 2014-007). Tilburg: Finance.
Blouin, J. ; Huizinga, H.P. ; Laeven, L. ; Nicodeme, G. / Thin Capitalization Rules and Multinational Firm Capital Structure. Tilburg : Finance, 2014. (CentER Discussion Paper).
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abstract = "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.",
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Blouin, J, Huizinga, HP, Laeven, L & Nicodeme, G 2014 'Thin Capitalization Rules and Multinational Firm Capital Structure' CentER Discussion Paper, vol. 2014-007, Finance, Tilburg.

Thin Capitalization Rules and Multinational Firm Capital Structure. / Blouin, J.; Huizinga, H.P.; Laeven, L.; Nicodeme, G.

Tilburg : Finance, 2014. (CentER Discussion Paper; Vol. 2014-007).

Research output: Working paperDiscussion paperOther research output

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AB - 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.

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Blouin J, Huizinga HP, Laeven L, Nicodeme G. Thin Capitalization Rules and Multinational Firm Capital Structure. Tilburg: Finance. 2014. (CentER Discussion Paper).