Disaggregating the Corporate Headquarters: Investor Reactions to Inversion Announcements by US Firms

• DOI: http://doi.org/10.1111/joms.12286
• Author: Arjen H. L. Slangen,Marc Baaij,Riccardo Valboni
• Published date: 01 December 2017
• Date: 01 December 2017

Disaggregating the Corporate Headquarters: Investor

Reactions to Inversion Announcements by US Firms

Arjen H. L. Slangen, Marc Baaij and Riccardo Valboni

Erasmus University Rotterdam and KU Leuven; Erasmus University Rotterdam; Utrecht University

ABSTRACT Internationally disaggregated headquarters arise from cross-border relocations of

headquarters components. To shed more light on the business consequences of such

component relocations, we analyse stock market reactions to inversion initiatives, which are

plans by US firms to offshore their registered seat. Combining business economics and

institutional theory, we develop an explanatory framework centred on repatriation taxes on

foreign income. Since inversions enable US firms to free themselves from such taxes in the

US, we hypothesize that inversions by firms that face higher US tax costs in repatriating

income will be received more positively by investors, and especially so if the inversion’s

destination country has no repatriation tax. Yet by freeing themselves from US repatriation

taxes, inverting firms deprive the US government of tax revenues and will therefore likely lose

legitimacy among US officials. The risks associated with losing such legitimacy, we argue, are

higher for firms that are more dependent on the US government, causing the relationship

between the US tax costs of repatriating income and investor reactions to inversions to be less

positive for such firms. We find substantial support for our framework in an event study of up

to 117 inversions announced over the period 1990–2016. Our findings argue for a nuanced,

contingency view of the business consequences of inverting and suggest that legitimacy losses

are not always as hazardous as previously thought.

Keywords: business economics, government dependence, HQ disaggregation, institutional

theory, inversions, investor reactions, repatriation taxes

INTRODUCTION

Relocations of headquarters (HQs) are important strategic events that have gained

prominence over the past decades (Birkinshaw et al., 2006; Laamanen et al., 2012). A

substantial body of research has analysed HQ relocations within the United States (US),

exploring their determinants and spatial patterns, as well as their impact on relocating

Address for reprints: Arjen H. L. Slangen, Erasmus University Rotterdam, PO Box 1738, 3000 DR, Rotter-

dam, The Netherlands (aslangen@rsm.nl).

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C2017 John Wiley & Sons Ltd and Society for the Advancement of Management Studies

Journal of Management Studies 54:8 December 2017

doi: 10.1111/joms.12286

firms’ stock prices and operating performance (for reviews, see Gregory et al., 2005;

Laamanen et al., 2012). Over time scholars became increasingly interested in HQ relo-

cations to foreign nations, resulting in several studies of the determinants of such reloca-

tions (Baaij et al., 2004, 2015; Benito et al., 2011; Birkinshaw et al., 2006; Forsgren

et al., 1995; Laamanen et al., 2012; Voget, 2011).

Much of the research on domestic and cross-border HQ relocations has focused on

management centres, i.e., corporate offices housing the executive management and

corporate-level support functions of a firm (Baaij and Slangen, 2013; Collis et al., 2007;

Strauss-Kahn and Vives, 2009). Yet besides having one or more corporate offices, every

lawful firm also has a registered seat in the form of a place where its highest legal entity

is registered (Baaij et al., 2015; Heron and Lewellen, 1998). This entity directly or indi-

rectly owns a firm’s other legal entities and provides the firm with a legal personality sep-

arate from that of its employees (Birkinshaw et al., 2006; Hannigan, 2015). Like

corporate office relocations, registered seat relocations to foreign nations have also

become increasingly common throughout the world (Voget, 2011). In the US, such relo-

cations have come to be known as ‘tax inversions’ because they enable US firms to

move their tax residence abroad and originally concerned foreign subsidiaries that were

turned into parents (Desai and Hines, 2002; Economist, 2015; Marples and Gravelle,

2016). Notable examples of US firms that have announced an inversion are Tyco Inter-

national, Herbalife, Burger King, Coca-Cola Enterprises, Medtronic, and Pfizer. Inver-

sions typically result in an internationally disaggregated HQ because even though they

are sometimes accompanied by a cross-border relocation of top executives, they are sel-

dom accompanied by a move of the inverting firm’s entire corporate office (Desai, 2009;

Webber, 2011). Disaggregated HQs thus not only arise from relocations of subsets of

HQ personnel (Baaij and Slangen, 2013), but also from registered seat relocations.

Even though HQ disaggregation by means of an inversion has become increasingly

popular among US firms, the business consequences of inverting have been underex-

plored. A good way to gain more insight into these consequences is to analyse stock mar-

ket reactions to inversion initiatives, since stock market reactions have been found to be

reliable indicators of the benefits and risks associated with a given corporate action (Fin-

kelstein and Haleblian, 2002; Harris and Shimizu, 2004). Extant studies of how invest-

ors react to inversion initiatives are scarce and based on very small samples, thus

providing limited empirical insight into the factors shaping investors’ assessments of

inversion decisions (Cloyd et al., 2003; Desai and Hines, 2002; Seida and Wempe,

2004). In this paper we aim to shed more light on these factors by developing an explan-

atory framework centred on repatriation taxes on foreign income and testing that frame-

work on the largest possible sample of the full population of inversions announced by

listed US firms. In developing our framework, we take an interdisciplinary approach by

combining insights from business economics and institutional theory. Specifically, we

argue that inversions enable US firms to free themselves from the American rule that

foreign income be taxed upon repatriation to the US. Since this rule is more disadvanta-

geous for firms that face higher US tax costs in repatriating income, we hypothesize that

inversions initiated by such firms will be received more positively by investors, and espe-

cially so if the inversion’s destination country does not levy a repatriation tax on inflows

of foreign income. However, by freeing themselves from US repatriation taxes, inverting

1242 A. H. L. Slangen et al.

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C2017 John Wiley & Sons Ltd and Society for the Advancement of Management Studies