Corporate responses to the repatriation incentives and domestic production activities deduction

The 2004 American Jobs Creation Act (AJCA or the Act) sought to encourage U.S. companies to repatriate foreign earnings and invest them domestically in an effort to increase capital spending and employment. This investigation looks at how the two tax provisions in AJCA, i.e., the repatriation tax holiday and the domestic production activities deduction (DPAD), affected domestic investment and payout behaviors. An examination of repatriating firms based on the tightness of their capital constraints shows that the tax incentives fail to induce non-constrained, repatriating firms that benefit from DPAD to reinvest the capital domestically. Only capital-constrained, repatriating firms benefitting from DPAD increase domestic investment and reduce share repurchases; however, these firms also increase their cash dividend payments. The findings should be useful to policymakers as they consider modifying the corporate tax structure to increase domestic investment by encouraging U.S. firms to repatriate foreign earnings and reinvest them domestically.     

Why do firms hold so much cash? A tax-based explanation

US corporations hold significant amounts of cash on their balance sheets. This paper develops and tests the hypothesis that the magnitude of US multinational cash holdings are, in part, a consequence of the tax costs associated with repatriating foreign income. Consistent with this hypothesis, firms facing higher repatriation taxes hold higher levels of cash, hold this cash abroad, and hold this cash in affiliates that trigger high tax costs when repatriating earnings. In addition, less financially constrained firms and those that are more technology intensive exhibit a higher sensitivity of affiliate cash holdings to repatriation tax burdens.     

Political costs and corporate tax avoidance: Evidence from sin firms

The products and services of firms operating in sin industries (alcohol, tobacco, gambling, and firearms) run contrary to social norms and can produce significant negative externalities for society. As such, we expect that sin firms are at greater risk of incurring political costs in the form of additional regulation, higher excise taxes, or capital market intervention if they come under scrutiny for their income tax avoidance practices. Because of the nature of their products, regulators and policymakers are likely to face less pushback on new regulations or taxes on these firms. Sin firms start with a lower ability to influence the political process than firms in non-sin industries. Consequently, we hypothesize and find that sin firms exhibit less tax avoidance than non-sin firms, particularly through uncertain and more risky tax avoidance strategies. The negative relationship between the status of sin firms and tax avoidance is less pronounced in firms that accumulate political capital via intensive lobbying activities. Exploiting changes in partisan control of the Congress and White House, difference-in-differences tests show that firearm firms engage in less (more) tax avoidance when the Democrats (Republican) control both the Congress and White House. Overall, we conclude that political costs play an important role in corporate tax avoidance decisions.     

The politics of government investment

This paper investigates the relation between corporate political connections and government investment. We study various forms of political influence, ranging from passive connections between firms and politicians, such as those based on politicians’ voting districts, to active forms, such as lobbying, campaign contributions, and employment of connected directors. Using hand-collected data on firm applications for capital under the Troubled Asset Relief Program (TARP), we find that politically connected firms are more likely to be funded, controlling for other characteristics. Yet investments in politically connected firms underperform those in unconnected firms. Overall, we show that connections between firms and regulators are associated with distortions in investment efficiency.     

Rent-seeking incentives, corporate political connections, and the control structure of private firms: Chinese evidence

We examine how the rent-seeking incentives of local government motivate private firms¹ listed in China to establish political connections, and whether such connections lead to more concentrated corporate control structures. Our results show that such firms are more likely to establish political connections in regions in which the local economy is less market-oriented or in which the government has more discretion in allocating economic resources. This is consistent with the notion that the presence of incentives for government officials to engage in rent seeking motivates private firms to look for alternative safeguards through political connections. We also find that the controlling owners of politically connected firms tend to concentrate their shareholdings and dominate the board of directors by occupying the position of either chairman or CEO, which supports the conjecture that a concentrated control structure facilitates rent seeking through political connections and allows the controlling owner to retain all of the benefits arising from connections with politicians.     

Political Party Affiliation of the President,Majority in Congress,and Sin Stock Returns

We find that in contrast to the stock market, which performs better during Democratic presidencies, “sin” stocks—publicly traded producers of tobacco, alcohol, and gaming—perform better during Republican presidencies and even more so when the Republican presidency is accompanied by a Republican majority in at least one chamber of Congress. We examine whether sin firms use contributions to establish connections with politicians and find that sin firms contribute more to Republican candidates and that these contributions are greater when Republicans are in power. We also find a positive relation between political contributions and future returns. The relation is stronger for contributions to Republicans.     

Paving the way for children: Family firm succession and corporate philanthropy in China

We investigate whether internal succession in family firms motivates founders to engage in corporate philanthropy. We argue that founders who intend to pass control of the firm to their children are likely to prepare for the internal succession by building up family assets such as reputation and political connections through corporate philanthropy. Supporting our argument, we find that both the likelihood and the amount of philanthropic donations increase when listed family firms in China are in the internal succession process. The effect of successions on philanthropic donations is stronger for family firms that have political connections or are located in areas with stronger government influence in the local economy. The effect concentrates on family firms when heirs are young and inexperienced. When heirs are established, family firms actually make fewer philanthropic donations. Our results remain robust after addressing endogeneity issues.     

The role of stock ownership by US members of Congress on the market for political favors

I examine whether stock ownership by politicians helps to enforce noncontractible quid pro quo relations with firms. The ownership by US Congress members in firms contributing to their election campaigns is higher than in noncontributors. This bias toward contributors depends on the financial incentives of politicians and the relation's value. Firms with a stronger ownership–contribution association receive more government contracts. The financial gains from these contracts are economically large. When politicians divest stocks, firms discontinue contributions to the politicians, lose future contracts, and perform poorly. Politicians divest the stocks in contributors, but not in noncontributors, in anticipation of retirement.     

Do Political Connections Affect Firm Performance? Evidence from a Developing Country

We investigate how politicians serving on the boards of directors influence firm performance. The results show a negative relationship between political connections and firm performance. Specifically, politically connected firms underperform nonconnected firms directors by almost 17 percent and 15 percent based on return on assets and return on equity, respectively. By stratifying the sample duration into two periods based on the political environment, we find that this effect is more pronounced in autocratic as opposed to democratic regimes. Finally, our results also suggest that the performance of connected firms with more growth opportunities is not affected by political connections.     

SEC comment letters related to permanently reinvested earnings

In this paper, we examine how permanently reinvested earnings (PRE) and disclosure transparency surrounding PRE influences external monitoring from the Securities and Exchange Commission (SEC). Our research is motivated by increased congressional and SEC scrutiny into companies with substantial PRE via their foreign operations. We hypothesize that firms are more likely to receive a PRE-related comment letter if they have large amounts of PRE, a large estimated hypothetical tax on repatriation, increases in PRE, and have less transparent disclosures related to the hypothetical tax on PRE. We find that the estimated hypothetical tax on repatriation and the transparency of PRE disclosures are determinants of receiving a PRE-related comment letter. Further analysis shows that cash-constrained firms with a large estimated hypothetical tax on repatriation are more likely to receive a PRE-related comment letter. Our research contributes to a growing body of research into the external monitoring role of the SEC in the form of comment letters.     

International tax reform: its effect on repatriation decisions of multinational corporations

The purpose of this research is to identify the ways in which post-1986 international tax reform is expected to affect the repatriation decisions of multinational corporations (MNCs) and to develop expectations about the degree to which future tax reform initiatives will result in the full convergence in rates across international boundaries. The research presents comparative income tax rate data for 14 developed countries and the 11 European Monetary Union (EMU) member states for the 1985–1997 period. All countries reduced their top corporate income tax rate during that period, and the inter-country variation in rates decreased. The reduction in the variation in rates across countries should provide MNCs with more flexibility in dividend repatriation decisions as the difference in tax cost between repatriating foreign earnings and reinvesting them abroad is diminished. Although the research shows a trend toward more similar rates during the 1985–1997 period, it also identifies and discusses political pressures that mitigate against the full convergence in rates.     

Stock Recommendations for Politically Connected Firms

Social network connections of corporations can significantly affect operating performance and firm valuation. Political connections are one form of social networking which often manifests into improved firm profitability as a result of political favors granted by politicians. However, analysts often have greater difficulty forecasting the earnings of politically connected firms than those of non‐connected firms. This is because politicians often grant political favors to firms in an unpredictable manner making it difficult for market participants to time precisely when political benefits will translate into higher firm profitability. I examine how political connections affect analysts’ stock recommendations using a unique dataset of political contributions in the US over the period 1993–2012. I show that analysts’ recommendations are less profitable for firms with high connectedness than for firms with low (or no) connectedness. I also find that analysts are less effective in translating earnings forecasts into profitable recommendations for highly connected firms. Overall, the findings suggest that analysts do not impound all of the information concerning corporate political connections efficiently into their primary research outputs.     

Mutual funds as monitors: Evidence from mutual fund voting

We address how mutual funds vote on shareholder proposals and identify factors that help determine support of wealth-increasing shareholder proposals. We examine 213,579 voting decisions made by 1799 mutual funds from 94 fund families for 1047 shareholder proposals voted on between July 2003 and June 2005. In an analysis of voting across funds within the same fund family, we find significant divergence in voting within families, emphasizing the importance of focusing on voting by individual funds. We also find that, in general, mutual funds vote more affirmatively for potentially wealth-increasing proposals and funds' voting approval rates for these beneficial resolutions are significantly higher than those of other investors. Our results suggest that funds tend to support proposals targeting firms with weaker governance. We also find that funds with lower turnover ratios and social funds are more likely to support shareholder proposals. Finally, fund voting approval rates significantly impact whether a proposal passes and whether one is implemented.     

Regional favoritism and tax avoidance: evidence from China

This paper investigates the effect of officials’ regional favoritism on corporate tax avoidance activity in China. We find that firms located in regions that were formerly administered by the current provincial governors have a higher level of tax avoidance than other firms in the province. Further evidence indicates that regional favoritism affects tax avoidance through two channels: regional politicians’ personal connections with the governor and firms’ political access to the governor. Overall, the findings support China's current official selection and promotion guidelines that restrict hometown favoritism. Our results further imply that favoritism can also extend to officials’ former administrative regions.     

How the Legal System Affects the Equity Mix in Executive Compensation

We examine variation in relative use of equity-based compensation (equity mix) across firms from different legal environments by studying 381 non-US firms from 43 countries during the 1996-2000 period. These firms are from countries that provide varying degrees of legal protection for shareholders. The data indicate association between equity mix and the degree of legal protection of shareholder rights. Specifically, firms use relatively more equity-based compensation if in a legal environment where shareholder rights are more strongly protected and where laws are more effectively enforced. These findings add to the literature demonstrating a relationship between institutional factors and financial decisions.     

Politicians and the IPO decision: The impact of impending political promotions on IPO activity in China

This paper shows that incentives created by the impending turnover of local politicians can accelerate the pace of initial public offering (IPO) activity in certain politicized environments. Focusing on China, we exploit a research setting where politicians are rewarded for capital market development, firms rely on political connections for access to capital, rent-seeking behavior is rampant, and the objectives of the state might not be to maximize capital market efficiency. We find that the rate of exchange eligible firms engaging in an IPO temporarily increases in advance of impending political promotion events. This effect holds for both state-owned and non-state-owned entities. For state-owned firms, the effect is strongest in those provinces where the politicians are more likely to be rewarded for market development activity. For non-state-owned firms, the temporary increase in IPO activity appears to be (rationally) opportunistic in nature, with the effect stronger around events more likely to disrupt the firms' political connections. Promotion period IPOs underperform non-promotion period IPOs in terms of both future financial performance and long-run stock returns, have controlling shareholders who retain a larger fraction of the company, and are more likely to divert proceeds away from their intended use after the offering.     

The taxman cometh: Does tax uncertainty affect corporate cash holdings?

We examine whether firms hold more cash in the face of tax uncertainty. Because of gray areas in the tax law and aggressive tax avoidance, the total amount of tax that a firm will pay is uncertain at the time it files its returns. The tax authorities can challenge and disallow the firm’s tax positions, demanding additional cash tax payments. We hypothesize that firms facing greater tax uncertainty hold cash to satisfy these potential future demands. We find that both domestic firms and multinational firms hold larger cash balances when subject to greater tax uncertainty. In terms of economic significance, we find that the effect of tax uncertainty on cash holdings is comparable to that of repatriation taxes. Our evidence adds to knowledge about the real effects of tax avoidance and provides a tax-based precautionary explanation for why there is such wide variation in cash holdings across firms.     

Employee sentiment and stock option compensation

The use of equity-based compensation for rank-and-file employees is a puzzle. We analyze whether the popularity of option compensation may be driven by employee optimism, and show that optimism by itself is insufficient to make option compensation optimal. The crucial insight is that firms compete with financial markets as suppliers of equity to employees and that employees’ access to the equity market restricts firms’ ability to profit from employee optimism. Firms must be able to extract some of the implied rents even though employees can purchase company equity in the financial markets. Such rent extraction becomes feasible if employees prefer the stock options offered by firms to the equity offered by the market, or if the traded equity is overvalued. We provide empirical evidence that firms use broad-based option compensation when boundedly rational employees are likely to be excessively optimistic about company stock, and when employees are likely to strictly prefer options over stock.     

CEO characteristics,firm performance,and corporate political contributions

We investigate if CEO characteristics determine the choice of Political Action Committee (PAC) contributions by firms and if such participation leads to better firm performance. Using a unique, hand‐collected database, we also focus on the identity of the politicians receiving PAC contributions to examine the impact of the value‐relevance of such contributions. Examining data on corporate contributions made to candidates seeking federal office during the 2002, 2004, and 2006 election cycles, we find that CEO dominance and interest alignment influence strategic choices of firms with regards to establishing PACs. Our analysis of value‐relevant contributions shows that firms prefer to donate to politicians representing the state of a firm's headquarters, validating the truth to the adage that all politics is local. However, these targeted political contributions do not have a discernible impact on firm performance.     

Does shareholder approval requirement of equity compensation plans matter?

This paper studies the impact of the 2003 SEC Regulation requiring shareholder approval of all equity-based executive compensation plans on executive compensation policies and practices at S&P 500 firms. Following the 2003 Regulation, firms with shareholder approved equity plans in place or those with strong performance, while not those with non-approved plans or weak performance, increase their equity compensation proposal submission activity. The quality of equity compensation proposals improves in the after-regulation period, and shareholders exhibit greater scrutiny and monitoring of executive compensation through increased voting rights. We find a decline in the equity pay component while an increase in the cash component of total executive compensation after the 2003 Regulation and also provide evidence that the 2003 Regulation contributes to this change in compensation structure.