Leverage, Corporate Taxes and Debt Shifting of Multinationals : The Impact of Firm-Specific Risk

Firms have the incentive to enhance debt financing with higher corporate tax rates due to the increased value of interest deductions from the tax base. However, external debt is relatively costly for corporations with a high firm-specific risk. Moreover, for multinationals, the shifting of internal debt opens up additional tax saving opportunities. Using a large database of European multinationals for the years 1998–2006, first, we provide evidence that the debt-to-assets ratio is positively affected by the statutory corporate tax rate. Second, we show that multinational subsidiaries use debt shifting with the parent as well as external debt to get advantage of the depreciation tax shield. Third, we provide evidence that subsidiaries with a high firm-specific risk are more involved in debt shifting than low-risk subsidiaries. Vice-versa, low-risk affiliates use external debt more intensively. We address endogeneity concerns on our firm-specific risk proxies with a sectoral analysis comparing high-risk with low-risk industries based on exogenous information and find a similar, even more extreme pattern