The effects of taxes and stock repurchases on domestic and multinational companies’ debt levels

• Published date: 01 April 2022
• Author: Hanni Liu
• Date: 01 April 2022
• DOI: http://doi.org/10.1002/jcaf.22542

Received: 18 December 2021Revised: 25 February 2022Accepted:25 January 2022

DOI: 10.1002/jcaf.22542

RESEARCH ARTICLE

The effects of taxes and stock repurchases on domestic

and multinational companies’ debt levels

Hanni Liu

O’Malley School of Business, Manhattan

College, Riverdale, New York,USA

Correspondence

Hanni Liu, O’Malley School of Business,

Manhattan College, Riverdale, NY 10471,

USA.

Email: Hliu01@manhattan.edu

Abstract

In past decades, corporate debt levels have risen tohistorical highs and remained

elevated. This study examines one of the key reasons that caused the high debt

levels––income taxes. Specifically, this study contraststhe effects of tax planning

on corporate debt levels in domestic companies (DCs) and multinational compa-

nies (MNCs) in the United States. It also explores how stock repurchaseenhances

such effects. The findings show that the association between debts and the out-

comes of tax of planning is stronger in DCs than in MNCs. This suggests that

DCs are more likely to use debt tax shields than MNCs. In addition, compared

to tax-efficient DCs, tax-efficient MNCs are more likely to borrow in order to

repurchase stock, resulting high debt levels. Moreover, the study provides evi-

dence that the credit rating adjusts DCs’ and MNCs’ credit ratings when they

raise debts to repurchase stocks.

KEYWORDS

credit rating, leverage ratio,multinational companies, stock repurchase, tax avoidance, the Tax

Cuts and Jobs Act

JEL CLASSIFICATION

G30, G32

1 INTRODUCTION

Prior research results have suggested that corporate debt

levels have risen significantly since the 2008 financial cri-

sis (De Almeida & Tressel, 2020; Lund et al., 2018, Board of

Governors of the Federal Reserve System (US), 2021). The

Joint Economic Committee of the United States Congress

[JEC] (2019) reported that the total amount of corporate

debt in the United States approached $10 trillion as of the

second quarter of 2019. While the chairman of the Fed-

eral Reserve concluded in a May 2019 speech that “the

costs of servicing today’s higher levels of debt remain low

relative to business income,” he also pointed out that if

there was an economic downturn, “some firms would face

challenges” (Powell, 2019). The coronavirus pandemic in

2020 made the worst part of that prediction come true,

and many highly leveraged businesses experienced finan-

cial distress in 2020.

While the economy is recovering, it is important to look

at the past and examine how we got here. Many rea-

sons have caused the high corporate debt levels, and the

focus of this study is on income taxes. Specifically, the

study contrasts the debt levels caused by different tax plan-

ning strategies implemented by domestic companies (DCs)

and multinational companies (MNCs). Under the United

States tax codes, MNCs have been in a better position

than DCs to shift income to low-tax jurisdictions. MNCs

can either adjust their international transfer pricing or

moving valuable intangible properties offshore (Blouin &

Krull, 2009; Dharmapala et al., 2011; Klassen & Laplante,

2012a, 2012b).1Relative to MNCs, DCs are more likely to

exhaust their available tax planning strategies and adopt

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strategies such as choosing debt over equity in order to

receive interest expense deductions.2Despite such dif-

ferences in DCs and MNCs, past studies analyzing the

capital structures of DCs and MNCs often omit taxation

(Burgman, 1996; Doukas & Pantzalis, 2003; Lee & Kwok,

1988; McMillan & Camara, 2012;Mittoo&Zhang,2008),

including the study by Park et al. (2013), who suggest that

there is no difference in the leverage ratios between DCs

and MNCs.

With the rising debt levels, US MNCs cash holdings

have increased at the same time (Begenau & Palazzo,

2021; Faulkender et al. 2019;Graham&Leary2018). This

is because when MNCs shift income offshore, their cash

becomes “trapped.” This cash trap lasted for decades until

the introduction of the Tax Cuts and Jobs Act (TCJA) in

December 2017. In a 2015 report, Rubin(2015) suggests that

US companies have kept$2.1 trillion overseas to avoid taxes

on repatriated dividends. Investors and analysts haveoften

urged MNCs to return cash to shareholders. For example,

in 2014, investor Carl Icahn wrote an open letter to Tim

Cook, Apple’s chief executive officer (CEO), urging him

to buyback Apple stocks. At the time––and to this day––

Apple had more than $100 billion in cash and marketable

securities and around $100 billion term debt on its balance

sheet. Early evidence suggests that the TCJA does not seem

to have reversed the growth trend of MNCs’ cash holdings

or debt levels (Hankins & Petersen 2020; Smolyanskyet al.,

2018).

The use of debt to buyback stock in MNCs has been

documented by several media and academic reports (Bul-

lock & Demos, 2011; Nessa, 2017; Richards & Craig, 2014;

Savitz, 2012). On the surface, borrowing money to repur-

chase stock seems to make financial sense since interest

rates have been at historically low levels following the

2008 financial crisis. However,it is unclear whether adding

more debt to buyback stock actually benefits sharehold-

ers. The International Monetary Fund [IMF] (2019)Global

Financial Stability Report indicates that US firms repur-

chase a great number of their own stocks and that many of

the repurchases are funded by debt (IMF, 2019,p.20).The

IMF cautions that a higher debt level may lead to worse

credit quality. If this is always the case, it would be diffi-

cult for MNCs to continue to borrow and repurchase stocks

without increasing the costs of debt. However, there has

been no study analyzing the effects on credit quality caused

by MNCs’ borrowing to buyback stocks and whether the

effects are the same in DCs.

Motivated by the tax advantages and cash disadvantages

caused by income shifting, this study first compares the

outcomes of tax planning on the leverage ratios between

US DCs and MNCs from 2001 to 2018. Second, the analy-

sis investigates whether the debt levels of tax-efficient DCs

and MNCs are related to their stock repurchase. Next, the

analysis examines whether borrowing debt to repurchase

stock affects DCs’ and MNCs’ credit ratings differently.The

propensity score matching (PSM) and the two-stage least

squares (2SLS) are applied in the models to enhance the

comparability of DCs and MNCs and reduce the endoge-

nous association between sample firms’ debt levels, tax

planning, and credit rating. The results indicate that the

association between debts and outcomes of tax planning is

lower in MNCs than in DCs. Moreover, stock repurchase

enhances such associations in MNCs, suggesting that tax-

efficient MNCs have higher debt levels when they repur-

chase stocks. Finally, the study finds that credit upgrades

are more likely to happen in MNCs than in DCs when they

use debts to buyback stocks. This implies that credit rat-

ing agencies understand the differences between DCs’ and

MNCs’ costs of accessing internal cash.

Additional tests examine the effects of the TCJA on the

association between taxes and debts in DCs and MNCs.

The TCJA eliminates the tax costs of foreign dividend repa-

triation and introduces taxes on Global Intangible Low-tax

Income (GILTI). These changes may lessen the effects of

taxes on MNCs’ capital structure, but whether the TCJA

also changes the association between debts and outcomes

of tax planning in DCs and MNCs is still unclear.Using the

preliminary post-TCJA data, the study finds that the asso-

ciation between debt and taxes continues to be stronger

in DCs than in MNCs, and there is no significant change

in the effects of stock repurchase on such association after

the TCJA. However,given the significant impacts from the

2020 pandemic, future research should provide complete

findings regarding debt levels and the TCJA.

This study adds to the findings of Park et al. (2013)

by showing that capital structures of DCs and MNCs are

heavily influenced by their tax planning outcomes. This

research demonstrates that introducing taxation into the

research design highlights a clear variation in leverage

ratios between DCs and MNCs. Further, this study doc-

uments the integrated relations of taxation, capital struc-

tures, and stock repurchase in DCs and MNCs. Last, the

study suggests that credit rating agencies also play a role

in the formation of firms’ capital structures. As corpo-

rate debt levels remain high and pose a potential threat to

the economy,this study provides important information to

policy makers by showing that design of the tax codes can

have long-lasting unintended consequences. Future stud-

ies may analyze whether the association of taxes and debts

will converge between DCs and MNCs.

The remainder of this paper is organized as follows. Sec-

tion 2provides the literature review and hypotheses devel-

opment, while Section 3presents the multivariate models.

Then, Section 4reports the sample selection process, and

the regression results and sensitivity tests are discussed in

Section 5. Finally, the conclusion is presented in Section 6.