This paper analyzes how corporate taxation and regulatory requirements affect the location of financial sector FDI. We use novel information on new financial services entities established by multinational firms in 83 host countries. We find a negative effect of host country taxes on the probability of choosing a particular host location. We can also confirm a significant influence of the regulatory environment. For example, stricter (equity) capital requirements negatively affect location probabilities. Our empirical approach allows us to provide new insight in how a policy measure of a given country affects other countries by estimating cross-country tax and regulation elasticities.

Affiliates of multinationals borrow a considerable amount from their parent company, even when the parent is located in a high-tax country. This is at odds with standard theories of a tax-efficient capital structure. We set up a model that analyzes the functioning of the internal capital market and investigates the trade-off between tax savings and capital market frictions within the group. We test the model on data of the universe of German multinationals. The empirical analysis largely supports our model in that: (i) smaller multinationals often rely on parental debt financing; (ii) larger multinationals are more likely to use internal banks; (iii) parental debt and external debt are substitutes and the mix depends on the relative cost of raising capital through the parent and the affiliates; (iv) local and within-group tax incentives play an important role in determining all three types of debt.