International Debt Shifting: Do Multinationals Shift Internal or External Debt?

Multinational companies can exploit the tax advantage of debt more aggressively than national companies. Besides utilizing the standard debt tax shield, multinationals can shift debt from affiliates in low-tax countries to affiliates in high-tax countries. We study the capital structure of multinationals and expand previous theory by incorporating debt tax shield effects from both internal and external capital markets. A main finding is that firm value is maximized if both internal and external debt is used, and that internal lending should be conducted through a financial center in the lowest-taxed affiliate. Testing our model using a large panel of German multinationals, we identify all three debt tax shields. Our estimates suggest that internal and external debt shifting are of about equal relevance.