FOREIGN TAX CREDIT LIMITATIONS AND PUBLIC ISSUANCES BY UNITED STATES MULTINATIONALS: NEW EVIDENCE OF TAX CLIENTELES

Theoretical predictions of a relation between income taxes and financing choices are based on the concept that tax clienteles (defined by the tax benefit received on interest deductions) exist for alternative securities. The tax benefit of an interest deduction for a U.S. multinational is a function of its U.S. and foreign income taxes. The U.S. tax system allows firms to take a foreign tax credit (FTC) against their foreign income taxes; however, the FTC amount is subject to a limitation. Binding FTC limitations reduce the marginal tax benefit of interest deductions because the interest tax shield is offset by a related decrease in the FTC.; This study tests for a relation between the impact of FTC limitations on the marginal tax benefit of interest deductions and the issuance choices made by U.S. multinationals raising capital in the public markets. The empirical model also includes tax variables for net operating loss and business tax credit carryforwards, as well as controls for other factors that influence financing choices. The results provide strong evidence that the likelihood of a U.S. multinational publicly issuing equity rather than debt increases with the impact of FTC limitations on the marginal tax benefit of interest deductions. U.S. multinationals with net operating loss carryforwards or business tax credit carryforwards also are found to be more likely to issue equity.; The empirical results are important for two reasons. First, evidence that binding FTC limitations can increase the cost of debt financing to the extent that public issuances are impacted is consistent with current arguments that U.S. foreign tax policy undermines the competitiveness of U.S. multinationals. Second, the study finds clear evidence of a relation between income taxes and firms' financing choices. In particular, the finding that taxable firms substitute between unused foreign tax credits and interest deductions is important because prior research generally has found no empirical evidence of a relation between income taxes and financing choices, or has only found evidence of such a relation for those firms paying little or no income taxes.