TAXATION AND MULTINATIONAL CAPITAL STRUCTURE (CAPITAL STRUCTURE)

A parent firm owns both domestic and foreign subsidiaries. Earnings and exchange rate uncertainties are modelled with a state-space framework. At a subsidiary, the net tax benefit to debt financing is a decreasing function of debt, because in some states of the world earnings are not sufficient to fully utilize debt and non-debt tax shields. Tax shields may not be completely lost however, if the subsidiaries are able to transfer income between themselves in order to "share" deduction. The extent to which this is possible can strongly affect the probability of losing tax shields. Given that the subsidiaries may be able to share tax shields, and their earnings may be taxed at different rates, the parent chooses subsidiary capital structures to maximize overall firm value.; Optimal borrowing and currency composition for debt may vary across subsidiaries because the probability of losing tax shields depends on subsidiary specific non-debt deductions and the correlation between that subsidiary's earnings and the exchange rate. The ability to share deductions is modelled analytically and graphically. A "base case" model that illustrates the ability to share tax shields between subsidiaries is solved.; An equivalent martingale approach is used to capture the effect of risk aversion. Conditions under which the parent is indifferent to borrowing and currency composition are developed. Closed form equations are provided assuming a multivariate normal distribution for the earnings and exchange rate. Conditions under which the currency composition and total debt decision are separable, are provided. A debt market equilibrium is developed in a risk neutral economy.; A sensitivity analysis is performed on an example problem. Monte Carlo methods are used to solve for the optimal debt and currency composition under alternate distributional assumptions. Scenarios that consider different abilities for sharing tax shields between subsidiaries are analyzed. Finally, a model is developed to consider the effect of a debt allocation restriction similar to S861- S864 of the U.S. tax code. Optimal borrowing with and without the debt allocation restriction, and its effect on tax revenue are considered.