Taxation, Foreign Tax Credits, Capital structure, Financing policy

We examine whether tax incentives influence where U.S. multinationals locate their interest deductions worldwide. Our sample includes international bond offerings by U.S. multinationals during 1987–1997 denominated in the currencies of Australia, Canada, France, Germany, Italy, Japan, or the United Kingdom. Our results suggest that U.S. multinationals’ debt location decisions take into account the effect of jurisdiction‐specific tax‐loss carryforwards and binding foreign tax credit limitations on the value of debt tax shields. Our results are also consistent with U.S. multinationals locating interest deductions in different tax jurisdictions as a mechanism to achieve tax‐motivated income shifting.

We match large U.S. corporations' tax returns during 1989–2001 to their financial statements to construct a firm‐level proxy of firms' use of off‐balance sheet and hybrid debt financing. We find that firms with less favorable prior‐period Standard & Poor's (S&P) bond ratings or higher leverage ratios in comparison to their industry report greater amounts of interest expense on their tax returns than to investors and creditors on their financial statements. These between‐firm results are consistent with credit‐constrained firms using more structured financing arrangements. Our within‐firm tests also suggest that firms use more structured financing arrangements when they enter into contractual loan agreements that provide incentives to manage debt ratings. Specifically, we find that after controlling for S&P bond rating and industry‐adjusted leverage, our sample firms report greater amounts of interest expenses for tax than for financial statement purposes when they enter into performance pricing contracts that use senior debt rating covenants to set interest rates. Furthermore, we find that the greatest book‐tax reporting changes occur when firms become closer to violating these debt rating covenants. These latter findings are consistent with firms' contractual debt covenants influencing their use of off‐balance sheet and hybrid debt financing.

We examine the influence of corporate taxes on U.S. firms' financing methods for taxable acquisitions of 100 percent of a target corporation's stock. We conduct tests of acquirer firms' use of debt or internal funds as the funding source for these acquisitions over the period 1987‐97. Our results provide the first empirical evidence that U.S. firms' use of debt to fund acquisitions significantly declines as foreign tax credit limitations reduce the marginal tax benefits received from borrowing. This finding is consistent with earlier speculation that U.S. foreign tax credit provisions could materially affect the capital costs of U.S. companies in debt‐financed acquisitions. We also find that these firms are generally high‐tax‐rate corporations whose financing choices are not significantly influenced by whether they acquire target‐firm tax loss carryovers. Our findings contribute to the accounting literature on the influence of taxes on the structure and financing of corporate acquisitions.