International Taxation and The Direction and Volume of Cross-Border M&As

THE JOURNAL OF FINANCE • VOL. LXIV, NO.
3 • JUNE 2009
International Taxation and the Direction

and Volume of Cross-Border M&As
HARRY P. HUIZINGA and JOHANNES VOGET∗
ABSTRACT
We show that the parent-subsidiary structure of multinational firms created by cross-
border mergers and acquisitions is affected by the prospect of international double
taxation. Specifically, the likelihood of parent firm location in a country following
a cross-border takeover is reduced by high international double taxation of foreign-
source income. At the same time, countries with high international double taxation
attract smaller numbers of parent firms. A unilateral elimination of worldwide tax-
ation by the United States is simulated to increase the proportion of parent firms
locating in the United States following cross-border mergers and acquisitions from
53% to 58%.
A MULTINATIONAL TYPICALLY has a parent firm in one country and subsidiaries

in one or more foreign countries. In this setting, the location of the parent
firm generally affects the taxes due in the parent country and all the other
countries. Some parent countries tax the worldwide income of their resident
multinationals, whereas other countries exempt the foreign-source income of
their multinationals from domestic taxation. A multinational firm with a tax
residence in a country that imposes worldwide taxation risks being subject to
international double taxation on income generated outside the parent country.
Multinationals thus stand to benefit from judiciously choosing the location of
the parent firm so as to mitigate any international double taxation.
At the time of a cross-border takeover, the organizational structure of the
resulting multinational firm is designed from scratch. Cross-border mergers
and acquisitions (M&As) therefore offer a unique opportunity to study the
impact of international taxation on the parent-subsidiary structure of multi-
national firms. This paper provides empirical evidence that international tax
considerations have materially affected organizational outcomes of cross-border
M&As.
The merger of Daimler in Germany with Chrysler in the United States in 1998
offers an example where the international tax system appears to have been a
key consideration. This merger resulted in a multinational firm with a parent
firm (Daimler) located in Germany and a subsidiary (Chrysler) located in the
∗ Huizinga is from CentER, Tilburg University, and Voget is from CentER, Tilburg University
and the Centre for Business Taxation, Saı̈d Business School, Oxford University. We are grateful for
valuable comments from Campbell Harvey, Jenny Ligthart, Simon Loretz, Bertrand Melenberg,
Arthur van Soest, a referee, and seminar participants at Tilburg University. Voget acknowledges
financial support from the Netherlands Organization for Scientific Research (NWO).
1217
1218 The Journal of FinanceR
U.S. According to testimony given by Daimler-Chrysler’s chief tax counsel before

the U.S. Ways and Means Committee on June 30, 1999, the exemption from tax-
ation by Germany of dividend income from abroad in contrast to the U.S. system
of worldwide taxation was one of the main reasons for locating the parent firm
of Daimler-Chrysler in Germany (Bogenschütz and Wright (2000)). Another
interesting case is the formal merger of British Shell with Dutch Koninklijke
Olie in 2005. Shell and Koninklijke Olie already joined forces in 1903, but
had retained separate stock listings and separate tax residences in the United
Kingdom and the Netherlands. After the formal merger in 2005 following criti-
cism of its previous corporate structure, the new company became a tax resident
of the Netherlands, even though the firm took the legal form of a British public
limited company. Based on that decision, the Dutch exemption system applies
to the firm’s overall income rather than British worldwide taxation.
Our empirical work is the first to show that the international tax system
systematically affects organizational structure following international M&As.
We consider cross-border M&As involving any two countries among a set of
European countries, Japan, and the United States in the 1985–2004 period.
We collect extensive information on all these countries’ tax systems and partic-
ularly on their taxation of foreign-source dividend income received by resident
multinational firms. For each cross-border takeover, we construct two rates of
international double taxation for the two possible outcomes regarding which
of the two affected firms becomes the parent firm (rather than a foreign sub-
sidiary). These double tax rates can be used to calculate international double
tax liabilities incurred by the newly created multinational firm in the two pos-
sible scenarios as to parent firm location.
We find that international double tax liabilities in the realized parent-
subsidiary scenario are substantially lower than in the counterfactual case
where the structure is inverted. Specifically, the international double tax lia-
bility is calculated to be 0.62% of the combined firm’s worldwide pre-tax income
in the actual parent-subsidiary outcome, while it would be 2.11% of worldwide
income in the alternative case. We proceed to estimate the impact of double
taxation on the parent-subsidiary decision using a logit binary choice model.
This estimation allows for the inclusion of a range of control variables, such as
the relative size of the two merging firms, that affect the selection of the parent
firm. International double taxation is found to have a highly significant impact
on the parent-subsidiary structure. This result is robust to various changes in
model specification and estimation technique.
Our logit estimation results can be used to simulate the impact of a change
in the international tax system on the pattern of international parent firm se-
lection. As an interesting possibility, we examine the case in which the U.S.
unilaterally abolishes its system of worldwide taxation, thereby ceasing to sub-
ject the foreign-source income of its multinationals to international double tax-
ation. Such a regime switch, recently proposed by the President’s Advisory
Panel on Federal Tax Reform (2005), is estimated to increase the propor-
tion of cross-border takeovers resulting in a parent firm in the United States
from 53.1% to 57.6%. For 2004 data, this corresponds to an 8.6 billion dollar
International Taxation 1219
increase in the difference between outward and inward takeovers for the United
States.1
In this paper, we also estimate a gravity model of the number of M&As that
yield a parent firm in a particular country. The gravity model framework cap-
tures the fact that international double taxation affects both the total number
of M&As involving a country and the proportion of M&As resulting in a parent
firm in that country. In a benchmark regression, we find a semi-elasticity of the
number of M&As generating a parent firm in a country with respect to the dou-
ble tax rate of −1.7. This suggests that a one percentage point increase in the
double tax rate facing U.S. parent firms in 2004 would decrease international
acquisitions of U.S. firms by 1.9 billion U.S. dollars.2
The remainder of this paper is organized as follows. Section I reviews related
studies on international taxation, foreign direct investment (FDI), and M&As.
Section II describes the international tax system and presents our tax system
data. Section III discusses the M&A data. Section IV presents the estimation
results of the logit model of parent country selection, while Section V simulates
the impact of the U.S. adopting the exemption system of international taxa-
tion on parent firm selection. Section VI presents estimation results for the
gravity model of the number of M&As per parent country. Section VII offers a
conclusion.
I. Related Studies
The value of M&As resulting in an acquisition abroad is counted as outward
FDI of the acquiring country to the extent that the acquiring firm finances
the transaction in its home financial market. Cross-border M&As tend to con-
tribute importantly to overall FDI.3 Studies on taxation and FDI typically use
aggregate national or bilateral FDI data and hence do not distinguish between
the part of FDI due to M&As and other components of FDI. Among these stud-
ies, Grubert and Mutti (1991), Hines and Rice (1994), and Altshuler, Grubert,
and Newlon (2001) find that a one-percentage point increase in the local tax
rate reduces the FDI stock between 0.1% and 2.8%. Other studies, such as
Hartman (1984), Boskin and Gale (1987), Newlon (1987), and Young (1988),
use time-series data, yielding estimated tax elasticities of FDI of around −0.6.
All these studies focus only on local taxation and ignore international double
taxation.
1
In 2004, U.S. inward and outward M&As were valued at 81.9 and 110.0 U.S. dollars. The value
of all M&As involving the United States was 191.9 billion U.S. dollars. The change in the U.S. net
outf low of M&As is estimated to be 4.5% of this or 8.6 billion U.S. dollars. See Table B.4 of United
Nations Conference on Trade and Development (2005).
2
In 2004, U.S. outward M&As were valued at 110.0 billion U.S. dollars. The change in outward
M&As is estimated to be 1.7% of this, or 1.9 billion U.S. dollars. See Table B.4 of United Nations
Conference on Trade and Development (2005).
3
United Nations Conference on Trade and Development (2000, p. 10) discusses the differences
between cross-border M&A and FDI data, and it concludes that the data suggest that M&As have
contributed an increasing share of FDI f lows to developed and developing countries alike.
Slemrod (1990) and Hines (1996) recognize the importance of international

double taxation for inward U.S. FDI by distinguishing between investments
from countries with and without worldwide taxation of corporate income. In the
absence of worldwide taxation, the U.S. tax constitutes the overall tax on U.S.-
source income. Indeed, Slemrod (1990) finds some time-series evidence that U.S.
taxation more strongly affects investments from countries without worldwide
taxation. Hines (1996) further investigates how investments by the two groups
of countries across U.S. states vary with the state-level corporate income tax
rate. Countries with worldwide taxation are shown to invest relatively more
in U.S. states with high corporate income tax rates This ref lects the fact that
multinationals located in countries with worldwide taxation would be able to
obtain off-setting foreign tax credits for U.S. state taxes.
Two recent studies examine the impact of taxation on a multinational’s struc-
ture using firm-level data. First, Desai and Hines (2002) examine the role of
taxation in 26 cases of so-called inversions of U.S. multinationals in the 1982
to 2002 period. In these transactions, the international corporate structure is
inverted in the sense that the U.S. parent becomes a subsidiary, and the earlier
foreign subsidiary becomes the parent firm. These inversions serve to eliminate
U.S. worldwide income taxation of all previous foreign subsidiaries. In fact, in-
ternational double taxation is avoided (except for U.S. dividend withholding
taxes) if the new parent resides in a country with an exemption system. Desai
and Hines (2002) show that inverting firms typically face low foreign tax rates,
confirming that inversions yield tax benefits. Despite these tax benefits, how-
ever, corporate inversions are relatively rare due to a certain inertia. Interna-
tional double taxation potentially has an economically more significant impact
on the organizational structures of multinationals created through cross-border
M&As as considered in this paper, as in these instances organizational struc-
tures are made from scratch. Second, Devereux and Griffith (1998) examine the
impact of taxation on decisions of U.S. firms regarding whether and how to serve
European markets—the U.S. firm can choose to establish production facilities
in a European country or it can export to Europe. Taxation is found to affect the
choice of European production locations, but not the choice of whether to pro-
duce in Europe at all. Devereux and Griffith (1998) use data on multinationals
headquartered in the United States, hence taking a U.S. tax residence as given.
Several studies focus on non-tax determinants of the direction and volume of
cross-border M&As. Rossi and Volpin (2004), for example, report a governance
motive for cross-border takeovers. In particular, firms in countries with strong
shareholder protection tend to acquire firms in countries with poor shareholder
protection. This enables firms in countries with poor shareholder protection to
“import” better protection, possibly resulting in lower cost of capital and higher
firm valuation. In line with this finding, Bris and Cabolis (2008) find that an
industry’s market value increases when firms in that industry are acquired
by foreign firms residing in countries with better shareholder protection and
better accounting standards. In related work, Di Giovanni (2005) estimates a
gravity model of international M&A activity focusing on the size of financial
markets, using the corporate tax rate rather than a measure of international
double taxation as a control variable.
II. The International Tax System

Two firms from different countries are assumed to merge into a single multi-
national firm. They have to choose one of the two countries as the country in
which the parent firm resides. Let this country be denoted i, while the other
country is denoted j. In addition, the multinational has to decide whether to
operate a foreign subsidiary or a branch in country j. Both of these aspects of
the multinational’s organizational structure potentially have tax consequences.
As a main principle, the parent country has the right to tax the multinational’s
overall income on a worldwide basis. In practice, however, some countries only
tax a multinational’s domestically generated income on a territorial basis. The
selection of the parent country thus affects whether the multinational’s in-
come generated outside the parent country is potentially subject to additional
taxation by the parent country. The choice between a foreign subsidiary or a
foreign branch structure matters as well, as some parent countries tax foreign-
source income in the form of dividends received from foreign subsidiaries dif-
ferently from foreign active business income generated by foreign branches. In
practice, most foreign establishments take the form of a subsidiary. Therefore,
this section focuses on the international taxation applied to foreign dividend
income. In the Internet Appendix to this paper, available at www.afajof.org,
we discuss how international f lows of active business income may be taxed
differently.4
Income generated in subsidiary country j is first taxed in that country at
a corporate tax rate τ j , leaving a share 1 − τj of this income to be reinvested
or repatriated to the parent firm in the form of dividends. Table I provides
information on top corporate tax rates for our sample of European countries,
Japan, and the United States in 2004 as an index of the corporate tax burden.
These tax rates include representative subnational state and city taxes.5 The
subsidiary country j, in addition, may apply a nonresident dividend withholding
tax to dividends repatriated to country i at a rate ωij . See the Internet Appendix
for information on bilateral withholding taxes. Overall, the subsidiary country
taxes the multinational’s local income to be paid out as dividends at a rate
τj + (1 − τj )ωij .
Parent country i potentially taxes the foreign dividend income at a corporate
tax rate τi . Let τijdouble be the resulting rate of double taxation defined as the tax
rate to be paid by the multinational firm on income from country j in excess of
the corporate income tax τ j in subsidiary country j. This double tax rate depends
on whether the multinational firm can defer parent country taxation until repa-
triation and on whether, at the time of taxation, the parent country provides any
double tax relief from taxes paid in the subsidiary country. In the absence of any
deferral and double tax relief, the double tax rate τijdouble equals τi + (1 − τj )ωij ,
ref lecting both the parent country corporate income tax and the subsidiary
country withholding tax.
4
An Internet Appendix for this article is online in the “Supplements and Datasets” section at
http://www.afajof.org/supplements.asp.
5
Special rates were applicable to listed firms in Greece until 2000 and to manufacturing firms
in Ireland until 2002.
Table I
Tax Regimes across Countries in 2004
The first column lists top corporate income tax rates including representative state and municipal
taxes where applicable with respect to retained earnings. The second column lists the countries’
method of tax relief that applies to dividend income in the presence of a tax treaty. The last column
provides the same information in the absence of a tax treaty. The parent firm is assumed to hold
a majority in the dividend-paying subsidiary so that participation exemptions take effect. Three
superscripts, a, b, and c, may further qualify the tax regime: a, only 95% of the dividend is exempted;
b, only withholding taxes are credited but not the underlying corporate income tax; and c, only
dividend income from EU sources is exempted. Other dividend income is taxed. Tax credits are
provided for withholding taxes.
Dividend Taxation
Tax Rate With Tax Treaty Without Tax Treaty

Country of Residence (1) (2) (3)
Austria 34.0 Exemption Exemption

Belgium 34.0 Exemptiona Exemptiona
Bulgaria 19.5 Credit Creditb
Croatia 20.0 Exemption Exemption
Czech Republic 28.0 Credit Deduction
Denmark 30.0 Exemption Exemption
Estonia 0.0 Credit Credit
Finland 29.0 Exemption Creditb
France 35.4 Exemptiona Exemptiona
Germany 38.3 Exemptiona Exemptiona
Greece 35.0 Credit Credit
Hungary 17.7 Exemption Exemption
Iceland 18.0 Exemption Exemption
Ireland 12.5 Credit Credit
Italy 37.3 Exemptiona Exemptiona
Japan 42.0 Credit Credit
Latvia 15.0 Exemption Exemption
Lithuania 15.0 Exemption Exemption
Luxembourg 30.4 Exemption Exemption
Netherlands 34.5 Exemption Exemption
Norway 28.0 Exemption Exemption
Poland 19.0 Credit Credit
Portugal 27.5 Exemptionc Exemptionc
Romania 25.0 Credit Credit
Slovak Republic 19.0 Exemption Exemption
Spain 35.0 Exemption Credit
Sweden 28.0 Exemption Exemption
Switzerland 24.0 Exemption Exemption
United Kingdom 30.0 Credit Credit
United States 40.0 Credit Credit
In practice, most countries provide some form of international double tax

relief. Some countries operate a territorial or source-based tax system, and
effectively exempt foreign-source income from taxation. In this instance, the
double tax rate τijdouble is given by (1 − τj )ωij in the absence of deferral of
Table II
Expressions for the Double Tax Rate τijdouble
The variable τ i is the corporate income tax rate in parent country i; τ j is the corporate income
tax rate in subsidiary country j; ωij is the wiithholding tax rate for dividends repatriated from a
subsidiary in country j to a parent firm in country i. In the case of a direct foreign tax credit, foreign
corporate income taxes are taken to be deductible expenses against taxable corporate income in
the parent country.
Form of Double Tax Relief Condition Double Tax Rate τijdouble
None τi + (1 − τj )ωij
Indirect foreign tax credit τj + (1 − τj )ωij ≥ τi (1 − τj )ωij
τj + (1 − τj )ωij < τi τi − τ j
Direct foreign tax credit ωij ≥ τi (1 − τj )ωij
ωij < τi (1 − τj )(τi − ωij )
Exemption (1 − τj )ωij
Deduction (1 − τj )[ωij + (1 − ωij )τi ]
parent country taxation. Alternatively, the parent country operates a world-

wide or residence-based system. In this instance, the parent country taxes the
worldwide income of its resident multinationals, but it may provide double tax
relief in the form of a foreign tax credit for taxes already paid in subsidiary
country j. The OECD model tax convention, which summarizes recommended
practice, gives countries the option between an exemption and a foreign tax
credit as the only two ways to relieve double taxation.6
The foreign tax credit reduces domestic taxes on foreign-source income one-
for-one with the taxes already paid abroad. A foreign tax credit can be indirect
in the sense that it applies to both the underlying corporate income tax and
the dividend withholding tax. Alternatively, the foreign tax is said to be di-
rect and applies only to the withholding tax. In either case, foreign tax credits
in practice are limited to prevent the domestic tax liability on foreign-source
income from becoming negative. With an indirect foreign tax credit provided,
the multinational pays no tax in the parent country on account of the foreign
tax credit limitation if τj + (1 − τj )ωij ≥ τi . The double tax rate τijdouble then only
ref lects the withholding tax in the subsidiary country. Similarly, with a direct
foreign tax credit provided, the multinational pays no tax in the parent country
due to the foreign tax credit limit if ωij ≥ τi . A few countries with worldwide
taxation do not provide foreign tax credits, but instead allow foreign taxes to
be deducted from the multinational’s taxable income. For the various double
tax relief conventions, Table II summarizes expressions for the double tax rate
τijdouble that, in the case of a foreign tax credit, depend on whether the foreign
tax credit limitation is binding.
Countries tend to vary their method of double tax relief, that is, through
an exemption, credit, or deduction, based on whether they have concluded a
6
See OECD (2005) for the most recent version of the model tax convention.
tax treaty with the other country. Columns (2) and (3) of Table I show which
double tax relief method countries apply to treaty signatory and non-signatory
countries. The exemption method is seen to be the most common method of
double tax relief on dividend income from foreign countries with and without a
tax treaty, followed by foreign tax credits. Several countries, including Finland
and Spain, exempt dividend income from a treaty country, while they apply
a foreign tax credit to dividend income from a non-treaty country. In these
instances, the existence of a tax treaty makes the method of double tax relief
more generous. Among the European countries, most countries have concluded
bilateral tax treaties, even if some Eastern European countries are still in the
process of completing their treaty networks.7
Our sample consists of 30 countries. Thus, for each country we can calculate
29 double tax rates for dividends received (for outward FDI) and dividends paid
(for inward FDI) using the statutory information on corporate tax rates, divi-
dend withholding taxes, and international double tax relief conventions. These
double tax rates per country provide information on whether a country can
serve as a tax-advantaged location for parent firms (with low double taxation
of dividends received) and a tax-advantaged location for subsidiary firms (with
low double taxation of dividends paid out). Table III ranks our 30 countries on
the basis of the average double taxation of dividends received, while it also pro-
vides information on the average double taxation of dividends paid out. These
average double tax rates are equal-weighted across the 29 other countries.
At the top of Table III, we see that the Netherlands has an average double
tax rate of dividends received of only 1.3%. The Netherlands has a territorial
tax system so that this 1.3% is wholly due to nonresident dividend withholding
taxes levied by subsidiary countries. Other countries at the top of the table,
in particular, Denmark, Finland, and Sweden, similarly have a territorial tax
system. An interesting case is Ireland, which also has a rather low average
double tax on incoming dividends despite its system of worldwide taxation
with foreign tax credits. Ireland had a low tax rate of 12.5% in 2004, which
implies this country de facto exempts most foreign-source income. Japan and
the United States also levy worldwide taxation with foreign tax credits, but
these countries have relatively high corporate tax rates. This explains these
countries’ positions at or near the bottom of the table. On tax grounds, Japan
and the United States thus are not good residences for the parent companies
of multinational firms. From the table, we can see that the average rates of
double taxation of incoming and outgoing dividends bear little relationship to
each other. To illustrate, Greece and the United States are well placed to host
foreign subsidiaries, even if their tax systems do not favor parent location.
III. M&A Data and International Double Taxation

From the Thomson Financial SDC database, we select all mergers and ac-
quisitions involving any two countries in our sample of European countries,
7
See the Internet Appendix.
Table III
Country Ranking of Double Tax Rates on Dividends in 2004
The table is ordered in an ascending manner with respect to the average double tax rate τ̄id oubl e in
the first column that applies to foreign-source dividend income repatriated to the country of resi-
dence listed on the left on January 1, 2004. Averages are taken across all potential source countries
in the sample. Rates are reported in percentage points. Participation exemptions are taken into
account in calculating the tax rates. The second and third columns report two components of the
double tax. The variable Corei is the average double tax rate if withholding taxes are neglected. The
variable Whti is the average double tax rate if withholding taxes were the only source of double
taxation (equivalent to all countries exempting foreign-source income from taxation). Note that
double tax relief for withholding taxes is generally provided so that τ̄id oubl e is generally less than
the sum of Corei and Whti . The fourth column reports τ̄ dj oubl e , which is the average double tax rate
from the point of view of source countries. The countries listed on the left now represent the source
country and tax rates apply to dividends leaving the country. The last two columns again report
the two components of the double tax.
Dividends Received Dividends Paid
τ̄id oubl e Corei Whti τ̄ dj oubl e Corej Whtj

Country (1) (2) (3) (4) (5) (6)
Netherlands 1.3 0.0 1.3 1.3 0.6 0.9

Sweden 1.7 0.0 1.7 1.4 1.4 0.0
Finland 1.8 0.0 1.8 4.4 1.2 3.5
Denmark 2.1 0.0 2.1 2.9 1.1 1.8
Ireland 2.3 0.4 2.3 5.6 5.0 0.6
Luxembourg 2.8 0.0 2.8 1.0 1.0 0.0
Austria 2.9 0.0 2.9 4.1 0.6 3.8
France 3.0 1.3 1.7 2.0 0.5 1.7
Switzerland 3.0 0.0 3.0 5.8 2.8 4.1
Norway 3.3 0.0 3.3 4.1 2.0 2.6
Belgium 3.8 1.3 2.5 3.1 0.6 2.7
Italy 3.8 0.6 3.4 4.2 0.4 4.1
Germany 3.9 1.4 2.5 2.1 0.3 2.0
Spain 4.0 2.4 3.2 3.2 0.5 3.0
Croatia 4.5 0.0 4.5 8.1 4.2 6.1
Poland 4.5 1.2 4.1 6.9 3.2 5.1
Estonia 4.6 0.0 4.6 18.6 10.1 14.7
Lithuania 4.9 0.0 4.9 8.2 4.7 5.3
Hungary 5.2 0.0 5.2 9.1 3.5 6.8
Iceland 5.5 0.0 5.5 8.5 4.7 6.1
Slovak Republic 5.6 0.0 5.6 3.2 3.2 0.0
Latvia 5.9 0.0 5.9 9.0 5.4 5.7
United Kingdom 6.0 5.7 2.4 1.1 1.1 0.0
Romania 6.4 3.3 5.4 7.9 2.6 6.7
Bulgaria 6.9 3.1 5.5 9.1 3.8 7.4
Czech Republic 7.2 4.5 4.6 5.6 1.4 5.0
Portugal 7.8 5.5 4.2 5.7 1.4 4.9
Greece 9.8 9.2 4.4 0.5 0.5 0.0
United States 14.1 13.8 3.8 1.2 1.2 0.0
Japan 16.2 15.8 6.1 6.9 0.7 6.6
Total 5.2 2.3 3.7 5.2 2.3 3.7
Japan, and the United States from 1985 to 2004. The cross-border acquiring
firm becomes the parent firm of the newly created multinational firm, while
the target firm becomes a foreign subsidiary or branch.8 For tax purposes, the
newly created multinational is resident in the acquiring or parent country. The
database does not provide information on whether a subsidiary or a branch is
created. As subsidiary structures are more common, we take these to be the
benchmark case. In our empirical work, however, we consider the international
taxation of branches as a robustness check. The acquiring firm, as reported
by Thomson, becomes the immediate owner of the target firm. The database
also provides information on the ultimate owner of the newly acquired firm. In
some cases, the nationalities of the immediate and ultimate owners differ and
the ultimate owner uses a holding company in another country to acquire the
target. Corporate structures of this kind may aim to delay or avoid taxation by
the ultimate parent country. In a robustness check, we exclude countries where
multinationals commonly use organizational structures involving immediate
owners in other countries.
Table IV shows the number of acquiring firms and target firms in our sample
per country. The table also reports the value of acquired firms and target firms
per country if available. From the table, we see that Eastern European countries
tend to be home to relatively many target firms. Japan and the United States
instead are shown to attract relatively many acquiring firms despite these
countries’ high taxation of incoming dividends as seen in Table III.
Multinational firms are more likely to be concerned about the amounts of
international double tax to be paid than about double tax rates per se. Hence,
the selection of the parent firm in an international takeover can be expected to
ref lect the additional tax liability that is incurred one way versus the other. To
ref lect this, for each takeover we construct a double tax liability rate, denoted
θijdouble , defined as the incurred double tax liability as a share of the combined
firm’s worldwide pre-tax income if firm a (from country i) takes over firm b (in
country j) as follows:


 0 if P Ib ≤ 0

= τidj oubl e × P Ia +P if P Ib > 0, P Ia > 0
P I
θab
d oubl e b
(1)


Ib
 τ d oubl e if P I > 0, P I ≤ 0 ,
ij b a
where PIa and PIb are the pre-tax incomes of the two firms before merging to
proxy for expected future incomes, and τijdouble is the statutory double tax rate
discussed in the previous section. In expression (1), there is no double taxation
of the target’s income if this income is negative. Furthermore, the expression
avoids inf lating the tax burden variable θabdouble
beyond the statutory double
8
We do not have any information on pre-existing subsidiaries of the two merging firms. This
implies that we cannot check whether the parent firm of the newly created multinational firm will
be able to engage in worldwide tax averaging. This would potentially reduce the overall tax costs
of repatriations. Further, we cannot analyze how pre-existing subsidiaries are rearranged in the
new ownership structure.
Table IV
Outgoing versus Incoming Acquisitions
This table lists the number of acquiring firms (column (1)) and the number of target firms (column
(2)) per country. Column (3) lists the deal value of foreign acquisitions and column (4) lists the deal
value of acquisitions by foreign firms in millions of U.S. dollars. The sample includes all M&As
between listed countries recorded in the Thomson database from 1985 through 2004.
Number of Number of Value of Acquisitions Value of Target

Acquiring Target (Millions of Firms (Millions
Firms Firms U.S. Dollars) of U.S. Dollars)
Country (1) (2) (3) (4)
Austria 624 552 10,947 19,399

Belgium 940 995 63,923 62,269
Bulgaria 0 67 0 2,857
Croatia 6 39 120 1,538
Czech Republic 18 438 86 11,046
Denmark 852 761 25,097 27,646
Estonia 23 117 89 454
Finland 787 717 51,614 33,970
France 2,720 3,563 378,284 200,067
Germany 3,361 4,372 381,502 453,361
Greece 114 48 7,451 3,377
Hungary 46 428 888 7,069
Iceland 36 11 1,861 369
Ireland 792 409 28,207 22,084
Italy 882 1,610 70,579 83,971
Japan 1,073 398 82,879 41,202
Latvia 7 52 6 395
Lithuania 10 88 1 1,246
Luxembourg 205 127 20,105 19,759
Netherlands 2,173 1,728 203,345 172,100
Norway 554 639 19,455 34,786
Poland 27 570 403 13,831
Portugal 95 298 1,998 9,535
Romania 6 101 6 1,946
Slovak Republic 7 88 25 2,851
Spain 430 1,531 34,698 63,276
Sweden 1,682 1,299 96,144 128,616
Switzerland 1,310 1,105 173,394 57,662
United Kingdom 6,479 5,429 978,858 583,042
United States 8,142 5,821 535,888 1,108,131
Total 33,401 33,401 3,167,853 3,167,853
tax rate τijdouble if the acquiring firm’s income is negative.9 Straightforwardly,

θba
double
is the corresponding double tax liability rate if instead firm b takes over
firm a.
To calculate θab double
, we need information on the pre-tax incomes of both the
acquiring and target firms. For 626 M&As, this information is provided by the
9
If PIa < 0, we assume the parent firm can carry any losses forward or backward so that τ ij is
the applicable double tax burden.
Distribution of Double Tax Liability Rates

20
Effective Double Tax Rate
18
16
14
Inverted Mergers
12
10
8
Actual Mergers
6
4
2
0
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95
Percentile
Figure 1. The solid line describes the distribution of double tax liability rates θ double for actual
mergers ordered from the lowest to the highest double tax liability rate. The dashed line describes
the distribution of double tax liability rates θ double if all mergers were inverted.
Thompson database. To expand our sample, we obtain additional information

on pre-tax incomes for some firms from the Compustat Global and Compus-
tat North America databases using CUSIP company identification codes. In
this manner, we increase the sample of international M&As for which we can
calculate two-way double tax liabilities to 917. Our data sources provide us
with acquiring firm and target firm accounting data for only a subset of all
cross-border M&As. These data sources, however, are global in coverage and
data availability does not appear to be systematic so as to bias the subsequent
empirical work.
For our sample of M&As, we calculate that the average double tax liability
according to (1) is 0.62% of the merged firm’s worldwide pre-tax income. This
corresponds to an average annual absolute double tax liability of 4.4 million
U.S. dollars per M&A. Interestingly, if the parent-subsidiary structure were
inverted, the double tax liability rate would increase to 2.11% of worldwide
pre-tax income, which corresponds to an absolute annual double tax liability of
15.5 million U.S. dollars. These data suggest that the organizational structure
of multinational firms following cross-border M&As is chosen with interna-
tional double taxation in mind. Additional information on the distribution of
actual double tax liability rates and the rates for inverted mergers is provided in
Figure 1. The solid and dashed lines in the figure indicate the actual and coun-
terfactual double tax liability rates by percentile, respectively. The figure con-
firms that the mean actual double tax liability rate is lower than the coun-
terfactual. At the same time, the actual share of M&As subject to no double
taxation is larger than in the inverted case.
IV. The Direction of M&As

In this section, we provide empirical evidence on how double taxation affects
the direction of cross-border M&As given that we know that the transaction
takes place. For this purpose, we estimate a logit binary choice model of selecting
the acquiring and target firms.
A. Estimating Equation
Following Mitchell and Mulherin (1996), the binary choice model assumes
that mergers ref lect the synergies from combining two firms and that investors
value the individual firms and the merger correctly. Let Vab = xab β + εab be the
value of the merged company if firm a acquires firm b. In this expression, xab is
a vector of independent variables, including the double tax liability θab double
for
the case in which firm a acquires firm b, while β is a vector of coefficients and
εab is an error term with a Weibull distribution. Similarly, let Vba = xba β + εba
be the value of the newly created firm if firm b acquires firm a. The difference
in the two firm values, Vab − Vba , is given by
Vab − Vba = (xab − xba ) β + εab − εba , (2)
where the error term εab − εba follows a logistic distribution as seen in
McFadden (1973). If Vab − Vba > 0, then firm a will be the acquirer. Hence,
the probability of firm a taking over firm b is given by10

exp xab β
Prob (Vab − Vba > 0 | xab, xba ) = . (3)
exp xab β + exp xba β
The coefficients β can be estimated by way of the logistic regression model
exp(
xn β)
E[ y n |
xn ] = , (4)
1 + exp(
xn β)

1 if Vab − Vba > 0
where the dependent variable is y n = ,
0 if Vab − Vba ≤ 0
xn = (xab − xba )n , and n counts the mergers. The n cross-border takeovers are
taken to involve a total of m countries.
For simplicity of exposition, let a be the observed acquirer and b be the target.
In the vector
xn of regressors, we include m − 1 country dummy variables that
capture the propensity of a particular country to be the acquirer country rather
than the target country. This country dummy variable for, say, Austria can take
on one of three values as follows: (i) it is set to one if firm a is Austrian, (ii) it
is set to minus one if firm b is Austrian, and (iii) it is set to zero otherwise.
In addition to these country fixed effect variables, the vector
xn includes the
relative double tax burden variable,
θab double
= θab
double
− θba
double
, and several firm-
level and country-level controls.
10
The probability is conditional on there being a profitable opportunity for the two firms to
merge. We expect this condition to be independent of Prob (Vab − Vba > 0).
With a and b denoting the acquiring and target firms, it follows that the
dependent variable vector yn just contains 1’s and hence displays no variation.
A model with a constant dependent variable would, of course, obtain a perfect
but trivial fit if it included a constant among the regressors. Our country fixed
effect variables, however, are not constants and generally no linear combination
of these variables exists that adds up to a constant vector. Thus, our model can
be estimated in a nontrival way. Estimation is by maximization of the joint
log-likelihood function
n
exp(
xk β) exp(−
xk β)
log L = y k log + (1 − y k ) log . (5)
k=1
1 + exp(
xk β) 1 + exp(−
xk β)
With a and b marking the acquiring and target firms, yk equals one in (5) for
all k and the second term within the square brackets vanishes.11 Note that the
convention of letting firm a always be the acquiring firm is arbitrary and does
not affect the estimation results. To see this, let us invert the labeling for exactly
one transaction so that for this transaction firm b becomes the acquiring firm
and firm a is the target firm. Now the dependent variable vector yn is no longer
a unit vector, as it contains exactly one zero element. It is easily seen that
inverting the labeling convention for one deal does not affect the expression
for the log-likelihood in (5). Specifically, for this particular transaction k, yk
now equals zero (so that the second term between square brackets in (5) no
longer drops out), while
xk becomes the negative value of what it was before
(as xba − xab = −(xab − xba )). Hence, the log-likelihood expression remains the
same and the estimation yields the same coefficients β. Generally, we can, of
course, take firm a to be the target firm in any number of observed M&As
without affecting the estimation. We expect the estimation to yield a negative
coefficient on
θabdouble
, as double taxation by a country a makes parent firm
location in that country less likely.
The relative double tax burden
θab double
= θab
double
− θba
double
is due immediately
if subsidiary profits are repatriated to the parent country. Parent country tax-
ation can generally be deferred if profits are not repatriated, but there are
some exceptions.12 Specifically, deferral is not available under some conditions
in Japan, Portugal, Spain, the United Kingdom, and the United States. The
United States, for instance, denies deferral of U.S. tax on foreign-source pas-
sive income if the subsidiary tax rate is less than 90% of the U.S. tax rate and the
U.S. parent firm owns at least 10% of subsidiary shares. The United Kingdom
similarly denies deferral of U.K. tax on foreign-source passive income under cer-
tain conditions. Japan, Portugal, and Spain disallow deferral of domestic tax
11
Note that all regressors in
xn have to take on both negative and positive values for different
observations k to ensure that normal maximum likelihood estimation yielding a finite likelihood
is possible. This implies that each country should have at least one acquiring firm and one target
firm in the sample. This condition is satisfied.
12
Desai and Hines (2004, Figure 2) show that rates of profit repatriation of U.S. multinationals
have declined substantially since 1982, increasing the scope for deferral. For established multina-
tionals, Hines (1994) demonstrates that deferral importantly affects investment and profit shifting
incentives.
on a broader definition of foreign profit under some circumstances. Detailed

information on deferral rules in all five countries can be found in the Inter-
net Appendix. On the basis of this information, we construct bilateral dummy
variables Dab and Dba indicating whether parent country a allows deferral of
taxation on income from country b, and vice versa.
Frequently, we do not have sufficient information to see whether non-deferral
applies in a certain case. For instance, we do not know the mix of active and
passive income of the target. We therefore have to make certain assumptions to
be able to construct our deferral variables. Specifically, any necessary conditions
regarding the type of income, the rate of profit distribution, and the ownership
share of the parent that potentially trigger non-deferral are assumed to be
met. With these assumptions, Japan, Portugal, Spain, United Kingdom, and
the United States deny deferral if the subsidiary-country tax rate is rather low.
double,d
Next, we construct the variable
θab = Dab θab
double
− Dba θbadouble
as the part
of the double tax liability
θab
double
that can be deferred. Deferral makes parent
double,d
country taxes less burdensome and thus we expect
θab to have a positive
coefficient.
Among the firm-level controls in the set
xn ,
Size is a measure of the rel-
ative size of the two firms involved in the takeover. It is defined as the differ-
ence between the two firms’ assets divided by the sum of their assets (see the
Appendix of the main text for variable definitions and data sources). We expect
this variable to have a positive sign, as the larger firm is more likely to take
over the smaller one. Next,
Liquidity is the difference between the ratios of
liquid assets to total assets. The more liquid firm may find it relatively easy to
take over the other firm, as it has relatively little need for costly external funds
to finance the acquisition. Next,
Leverage measures the difference between
the leverage ratios of the two merging firms. This variable could ref lect rela-
tive borrowing capacity, for instance, on account of different costs of borrowing
(Desai and Hines (2002) argue that low leverage may ref lect high borrowing
cost and thus low borrowing capacity). A positive sign on
Leverage would sug-
gest that the more highly leveraged firm is more likely to be the acquirer. As an
alternative measure of borrowing capacity, we also use
Fixedassets, which is
the difference between the two firms’ ratios of fixed assets to total assets. Fixed
assets may easily serve as collateral and hence may signal borrowing capac-
ity (Rajan and Zingales (1995)). An acquiring firm may either wish to borrow
against its own fixed assets or against the target’s fixed assets, and hence the
expected sign for the
Fixedassets variable is not clear. The variable
ROA is
the difference between the rates of return on assets. More profitable firms are
expected to take over less profitable ones.
Parent firm location in a country will involve certain headquarter activities
that are subject to the parent country’s corporate tax rate. For this reason,
parent firm location in the high-tax country may be less likely. However, par-
ent firm location in the high-tax country may be more likely if a high taxation
regime implies high public spending on, for instance, infrastructure that bene-
fits parent firms. Thus, the difference between the two countries’ tax rates,
represented by
Taxrate, could take either sign. Next, we construct
Stockmarket as the difference between the two countries’ stock market cap-
italizations divided by their summed capitalization. The acquiring firm may
more easily raise equity capital in its domestic capital market and hence
Stockmarket is expected to have a positive sign. As in Di Giovanni (2005), the

variable is lagged one period to account for possible endogeneity. Along simi-
lar lines,
Credit is the difference between the two countries’ domestic credit
to the private sector divided by their total credit provision, all lagged 1 year.
The ease with which the acquiring firm may borrow in its own country or in
the target country depends on the importance of bank information about the
acquiring firm and the acquired assets. Thus,
Credit could take either sign.
Further,
Exch.rate is symmetrically calculated as the difference between the
annual percentage changes in the bilateral exchange rate lagged by 1 year. A
positive value for
Exch.rate implies past exchange rate appreciation, which
is expected to make foreign acquisitions more likely (Blonigen, (1997) and Di
Giovanni, (2005)). In a robustness check, we further include
Pretaxinc, which
is the difference between the pre-tax incomes divided by their sum. This vari-
able thus measures relative size by pre-tax income rather than assets. Again,
we expect the larger firm to take over the smaller one. Finally,
Investment
is the difference between the two firms’ ratios of investment to assets. Firms
with high investment rates may have profitable investment opportunities that
to some extent are transferrable to target firms, which could explain a pos-
itive estimated coefficient. Table V provides summary statistics for all these
variables. Note that the included country dummy variables serve to capture
country-specific determinants of M&A activity such as the legal and regulatory
framework and capital gains taxation. See Rossi and Volpin (2004), Dyck and
Zingales (2004), La Porta et al. (2002), Comment and Schwert (1995), and Ayers,
Lefanowicz, and Robinson (2003) for empirical evidence on these determinants
of M&A outcomes.
B. Estimation Results
Table VI presents the results of regressions explaining the direction of M&As.
In regression (1), the relative double tax burden variable
θ double enters with
a coefficient of −0.358 that is statistically significant. This suggests that an
increase in the double tax burden in one country by one percentage point re-
duces that country’s probability of being the acquiring country by 9.0 percentage
points in the case of a merger of equals. In comparison, the relative double tax
burden from the acquirer’s perspective is −1.5% on average as seen in Table V.
International double taxation thus affects M&A outcomes in an economically
significant way. Among the controls, the relative size variable enters with a pos-
itive and significant coefficient, suggesting that the larger firm is more likely to
be the acquirer. More liquid assets and greater leverage appear to also make it
more likely that a firm becomes the acquirer firm. The rate of return on assets
variable takes a negative coefficient, but it is statistically insignificant. The
relative tax rate takes a positive coefficient that is statistically insignificant.
Table V
Summary Statistics for Analysis of the Direction of M&As
The summary statistics describe the relative values of a variable for firms a and b for the case in
which the acquiring firm is classified as firm a and the target firm is classified as firm b. This
labeling matters for the value of these statistics. For example, the dependent variable y changes
from a unit vector to a zero vector and the explanatory variable means switch signs if the labels a
and b are switched for all firm pairs. y is a binary variable indicating whether firm a acquires firm
b or vice versa. For other variable definitions and data sources, see the Appendix of the main text.
Variable Obs Mean Std. Dev Min Max
y 917 1.00 0.00 1.00 1.00
θ double 917 −1.50 4.65 −30.00 27.50
θ double,d 582 −0.51 1.65 −16.30 5.80
Size 917 0.70 0.36 −0.99 0.99
Liquidity 582 0.00 0.20 −0.82 1.55
Leverage 582 −0.02 0.51 −5.36 3.18
Fixedassets 394 −0.16 0.19 −0.88 0.66
ROA 582 0.08 0.35 −1.18 3.01
Taxrate 582 0.42 10.09 −30.00 30.00
Stockmarket 582 −0.01 0.73 −0.99 0.99
Credit 582 −0.01 0.72 −0.99 0.99
Exch.rate 582 −0.02 0.18 −0.45 0.50
Pretaxinc 582 0.58 0.56 −1.00 1.00
Investment 346 0.05 0.22 −0.80 1.09
The relative stock market capitalization and credit provision variables enter
with positive and negative coefficients, respectively, that are both insignificant.
Finally, the exchange rate variable takes an unexpected negative, but insignif-
icant, coefficient.
In regression (2) we add the
θ double,d variable, which ref lects the part of
θ double that is potentially deferred. This variable enters with a negative coeffi-
cient, but it is statistically insignificant. This could indicate that the value of the
deferral option is uncertain to merging firms or that deferral has little value,
for instance, because it may lead to suboptimal reinvestment in the subsidiary
country. Also, the deferral variable may measure the expected availability of
deferral imperfectly.
The negative estimated coefficient on
θ double in regression (1) could merely
ref lect that firms with relatively high pre-tax incomes are likely to be acquiring
firms for reasons other than international double taxation. To exclude this
possibility, in regression (3) we include the relative pre-tax income variable as a
separate control variable. This relative pre-tax income variable takes a positive
coefficient, but it is insignificant. The relative double tax burden variable now
enters with a coefficient of −0.263 that remains statistically significant.
Regression (4) includes the relative investment variable as a control vari-
able. This reduces the sample size from 582 to 346 observations due to missing
investment cash f low data. The relative investment variable is estimated to
have a positive and significant coefficient. This could ref lect that firms with
Table VI
Estimation Results for the Direction of M&As
The dependent variable y equals one if firm a acquires firm b and zero if firm b acquires firm a.
All regressions are logit regressions except the probit regression (6) and the two-step instrumental
variable probit regression (10). Regression (7) assumes that target firms are integrated as foreign
branches instead of as subsidiaries. Regression (8) excludes deals with ultimate acquirers in four
countries that use holding companies relatively intensively. Regression (9) is a conditional logit
regression. The likelihood is maximized conditional on the number of acquiring and target firms
per bilateral relationship. Regression (10) is a two-step instrumental variable probit regression,
where the variables
θ double and
Taxrate are instrumented by their 1- and 2-year lagged values.
Country fixed effects are not reported. The Wald test of exogeneity has as null hypothesis that the
variables
θ double and
Taxrate are exogenous. With a χ 2 statistic of 0.79 and a p-value of 0.67, this
hypothesis cannot be rejected. The test of the overidentifying restrictions has an Amemiya-Lee-
Newey minimum χ 2 statistic of 3.11 and a p-value of 0.21. The hypothesis that the instruments
are valid cannot be rejected. The row labeled Corr. Class. reports the proportion of mergers the
direction of which is predicted correctly if 0.5 is chosen as the probability cutoff value. Standard
errors are provided in parentheses. Stars indicate the significance level: ∗ : 5%, ∗∗ : 1%. For variable
definitions and data sources, see the Appendix.
(1) (2) (3) (4) (5)

Benchmark Deferral Pretax Income Investment Fixed Assets
θ double −0.358∗∗ −0.357∗∗ −0.263∗ −0.501∗∗ −0.498∗∗

(0.086) (0.090) (0.119) (0.165) (0.180)
θ double,d −0.011
(0.254)
Size 5.698∗∗ 5.696∗∗ 5.453∗∗ 7.412∗∗ 10.397∗∗

(0.587) (0.589) (0.611) (1.231) (1.902)
Liquidity 3.160∗ 3.154∗ 2.950∗ 6.726∗∗ 3.252

(1.253) (1.259) (1.276) (2.414) (1.752)
Leverage 0.852∗ 0.850∗ 0.825 2.168

(0.431) (0.432) (0.428) (1.135)
Fixedassets −1.335
(2.524)
ROA −0.360 −0.359 −0.583 −0.449 −0.286

(0.778) (0.778) (0.746) (1.374) (1.766)
Taxrate 0.091 0.090 0.069 0.192 0.328∗∗

(0.056) (0.056) (0.060) (0.108) (0.118)
Stockmarket 1.420 1.403 0.943 −1.685 4.089

(2.737) (2.769) (2.769) (5.573) (5.034)
Credit −5.243 −5.217 −4.942 −3.041 −12.645∗

(3.143) (3.205) (3.169) (6.191) (5.807)
Exch. rate −1.659 −1.650 −1.827 −1.694 −4.694

(1.328) (1.346) (1.337) (2.162) (2.534)
Pretaxinc 0.617
(0.555)
Investment 6.646∗∗
(2.286)
N 582 582 582 346 394
Log-likelihood −77.4 −77.4 −76.7 −32.6 −28.0
Corr. Class. 95.4% 95.4% 95.2% 97.1% 97.2%
(continued)
Table VI—Continued
(6) (7) (8) (9) (10)

Probit Branch Holding Company Conditional IV
θ double −0.186∗∗ −0.355∗∗ −0.340∗∗ −0.322∗∗ −0.190∗∗

(0.044) (0.088) (0.088) (0.099) (0.047)
Size 2.978∗∗ 5.730∗∗ 5.399∗∗ 5.380∗∗ 2.893∗∗

(0.265) (0.592) (0.667) (0.706) (0.273)
Liquidity 1.545∗ 3.189∗ 2.899∗ 3.616∗∗ 1.510∗

(0.625) (1.245) (1.379) (1.342) (0.637)
Leverage 0.372 0.877∗ 0.902∗ 0.782 0.376

(0.235) (0.426) (0.427) (0.479) (0.219)
ROA −0.259 −0.321 −0.268 −0.598 −0.294

(0.400) (0.780) (0.851) (0.778) (0.380)
Taxrate 0.046 0.100 0.089 0.220∗∗ 0.048

(0.029) (0.056) (0.069) (0.083) (0.036)
Stockmarket 0.762 1.167 3.025 −3.448 0.729

(1.423) (2.730) (3.427) (4.757) (1.446)
Credit −2.939 −5.069 −6.221 −29.024∗∗ −2.731

(1.676) (3.134) (3.975) (8.708) (1.666)
Exch. rate −1.138 −1.793 −1.879 −0.324 −0.991

(0.678) (1.324) (1.558) (1.594) (0.713)
Wald test: 0.79/0.67
Overid test: 3.11/0.21
N 582 582 417 518 574
Log-likelihood −78.6 −77.7 −58.0 −46.1 n.a.
Corr. Class. 95.2% 95.2% 94.7% n.a. n.a.
high investment levels have profitable investment opportunities that can be

transferred to target firms. The relative double tax burden variable takes a
somewhat more negative coefficient of −0.501 that remains statistically signif-
icant. In regression (5) we replace the relative leverage variable by the relative
fixed assets variable as an index of borrowing capacity. The negative estimated
coefficient on the latter variable suggests that firms with relatively large fixed
assets make good targets, but the estimate is statistically insignificant.
Regression (6) applies the probit model rather than the logit model to specifi-
cation (1). This yields an estimated coefficient on the relative double tax burden
variable of −0.186 that is statistically significant. This estimate implies that
an increase in the double tax burden of one percentage point in a country re-
duces the probability of that country being the acquirer by 7.4% for the case of
a merger of equals. Thus, the calculated marginal effect of a change in double
taxation is slightly less than that for the logit model.
So far, we have assumed that a merger results in a multinational firm with a
foreign subsidiary. Alternatively, the multinational firm could opt for a branch
structure. As discussed in Section II, the international taxation of the income
of foreign subsidiaries and foreign branches generally differ. As a robustness
check, we construct the relative double tax burden variable
θ double on the
assumption that foreign establishments take the form of branches. The esti-
mated coefficient on the relative double tax variable for the branch case in
regression (7) is very similar at −0.355, and it remains statistically significant.
Two firms engaging in a cross-border merger can opt for a simple parent-
subsidiary structure or, instead, for a more complex structure involving a hold-
ing company in a third country. Our data source provides information on the
nationalities of the immediate and ultimate acquirers and thus we can check
whether international holding companies are prevalent in our sample. For the
582 transactions in the benchmark regression, these two nationalities differ
in 12 cases. These 12 transactions involve five countries of ultimate owner-
ship: France, Italy, Luxembourg, the Netherlands, and the United Kingdom.
In the case of France, 2 out of 36 ultimate owners in France use immediate
owners in other countries. For Italy, Luxembourg, the Netherlands, and the
United Kingdom, the corresponding figures are 5 out of 28, 1 out of 3, 3 out
of 39, and 1 out of 89, respectively. Regression (8) excludes transactions with
ultimate owners or targets in France, Italy, Luxembourg, or the Netherlands,
as ultimate owners in these countries use holding companies in other countries
in our sample relatively intensively. The estimated coefficient on the relative
double tax burden is similar at −0.340 and is statistically significant.
Next, regression (9) applies a conditional logit model to specification (1).
Specifically, the estimation is conditioned on information about the proportion
of firms that establish a parent firm in one of two countries for any pair of
countries.13 The estimated parameter for the relative double tax parameter is
very similar at −0.322 and is statistically significant.
Finally, we consider the possibility that corporate taxation is endogenous to
the direction of M&As. To see how endogeneity may arise, we can interpret
international double taxation as a user fee for using a country as the parent
country. Such a fee may be justified by, say, a country’s superior legal and ac-
counting environment or, alternatively, the smooth operation of its labor mar-
ket. An increase in the demand for a country’s services as the parent country
may endogenously give rise to an increase in the user fee, that is, a higher rate
of double taxation applied to resident parent firms. Such a positive response of
international double taxation to the location of parent firms in a country could
give rise to a positively biased estimated coefficient on
θ double . To adjust for
potential endogeneity, we apply a two-step instrumental variable probit, where
θ double and
Taxrate are instrumented by their 1- and 2-year lagged values.14
The relative tax burden variable now takes a coefficient of −0.190 as reported
in regression (10), which is very similar to the estimate of −0.186 in the pro-
bit regression (6). A Wald test of the hypothesis that
θ double and
Taxrate
13
For mergers between countries i and j (with i < j), we define all observations with headquarters
locating in country i as “successes” (yn = 1) and all observations with headquarters locating in
country j as “failures” (yn = 0). Conditioning the likelihood on the country-pair-specific number of
successes and failures results in Chamberlain’s (1980) fixed effects logit estimator, which allows for
the presence of fixed effects on the level of bilateral country relationships. See also Greene (2008,
pp. 800–805) for a good description of the fixed effects logit estimator.
14
For further details on the instrumental variable estimation, see the Internet Appendix.
are exogenous cannot be rejected. A test of the overidentifying restrictions in-

dicates that the hypothesis that the instruments are valid cannot be rejected
either. Overall, the results in this section show that the direction of interna-
tional M&As is affected by the prospect of international double taxation and
that the estimated effect is economically significant. This finding is robust to a
variety of changes in model specification and estimation technique.
V. Simulation of International Tax System Change by the

United States
Our empirical results suggest that countries can attract additional parent
companies by lowering international double taxation, either through lower tax
rates or more generous double tax relief. For the U.S. case, the President’s
Advisory Panel on Federal Tax Reform (2005) has recently advocated abolish-
ing the U.S. system of worldwide taxation in favor of an exemption system. The
American Jobs Creation Act of 2004 already temporarily allowed U.S. multina-
tionals to repatriate profits subject to a f lat tax rate of 5.25% from October 2004
until the end of 2005. In response, the foreign subsidiaries of U.S. multination-
als increased their repatriations sixfold from 34 billion U.S. dollars in 2004 to
217 billion dollars in 2005. This shows that the current system of worldwide
taxation in the United States has a material impact on the behavior of U.S.
multinationals. In this section, we present simulations of how an abolition of
worldwide taxation by the U.S. would affect the propensity of newly created
multinational companies in our sample to establish a parent firm in the United
States. The international tax systems of other countries are assumed to remain
unchanged. In our simulations, we use the estimated coefficients of regression
(1) in Table VI.
Column (1) of Table VII gives the proportion of multinational firms resulting
from M&As involving the United States that establishes a parent firm in coun-
try i. This proportion equals the average predicted probability Pi of parent firm
location in country i. Note that 53.1% of the deals actually resulted in a parent
firm in the United States. Column (2) gives the change in this proportion, or
dPi , that is simulated to occur after the U.S. switches to an exemption system,
while column (3) provides the corresponding relative change in the propensity
to choose a U.S. parent, or dPi /Pi . In columns (2) and (3), estimated changes
in the probability of establishing a U.S. parent are zero for Belgium, Germany,
Italy, Japan, and Spain, as these countries’ tax rates are so high in the sample
that the U.S. imposes no double tax on foreign-source income from these coun-
tries. All other “partner” countries see their chances of becoming the parent
country decrease. For Ireland, the probability of obtaining the parent firm falls
rather dramatically from 38.2% to 3.6%. This ref lects the fact that U.S. multi-
nationals operating in Ireland are subject to considerable U.S. tax due to the
low Irish tax rate of 12.5%. The United States itself experiences an increase in
the probability of becoming the parent country from 53.1% to 57.6%.
Columns (4) to (6) provide information about how the U.S. abolition of world-
wide taxation affects country i’s chances of hosting the parent firm following
Table VII
Simulation of Exemption System in the United States
This table reports the change in the proportion of acquiring firms per country if the United States
were to switch from applying worldwide taxation to exempting foreign income taxation. The vari-
able Pi is the original proportion of acquiring firms reported in percent and dPi is the corresponding
change in the proportion reported in percent. The variable dPPi i is the implied relative change in
the proportion. Marginal effects are calculated using regression (1) in Table VI and taking the
observations’ explanatory variable values into account. The first three columns relate exclusively
to mergers involving the United States. Austria, Greece, and Portugal have no values reported
because these countries do not have any U.S.-related merger in the sample. The last three columns
relate to all mergers in the sample.
U.S. Related M&As Only All M&As
(1) (2) (3) (4) (5) (6)

d Pi d Pi
Country Pi dPi Pi Pi dPi Pi
Austria 44.4 0.00 0.00

Belgium 94.5 0.00 0.00 66.7 0.00 0.00
Denmark 54.0 −10.16 −0.19 57.9 −5.88 −0.10
Finland 72.5 −14.77 −0.20 71.4 −5.63 −0.08
France 48.8 −0.21 0.00 48.7 −0.10 0.00
Germany 46.6 0.00 0.00 51.9 0.00 0.00
Greece 33.3 0.00 0.00
Ireland 38.2 −34.61 −0.91 66.7 −13.19 −0.20
Italy 69.7 0.00 0.00 66.7 0.00 0.00
Japan 51.7 0.00 0.00 50.0 0.00 0.00
Luxembourg 36.4 −1.10 −0.03 60.0 −0.66 −0.01
Netherlands 72.1 −0.48 −0.01 65.5 −0.24 0.00
Norway 32.3 −0.81 −0.03 20.0 −0.27 −0.01
Portugal 50.0 0.00 0.00
Spain 59.0 0.00 0.00 42.9 0.00 0.00
Sweden 58.4 −5.35 −0.09 54.5 −2.43 −0.04
Switzerland 71.9 −5.58 −0.08 71.0 −2.34 −0.03
United Kingdom 35.8 −6.02 −0.17 33.8 −4.35 −0.13
United States 53.1 4.50 0.08 53.1 4.50 0.08
Total 50.0 0.00 0.00 50.0 0.00 −0.01
cross-border deals involving any country (and not just the U.S.). These columns
report how deals involving the United States are affected, as before, and also a
country’s proportion of deals with the United States. The probability of a parent
firm in Ireland is now reduced by about 13 percentage points, which ref lects
that about a third of the deals involving Irish firms are with a U.S. partner. All
the same, the redistribution of parent firm activity toward the United States
from Ireland and several other countries remains substantial.
VI. The Gravity Model and the Number of M&As

Previous sections analyze the direction of individual cross-border mergers
using firm-level data. In this section, we take a macroeconomic perspective.
Specifically, we consider how international double taxation affects parent firm
location at a bilateral, national level taking a gravity model approach. Several

previous studies use the gravity model to explain international investment
outcomes. Portes and Rey (2005), for instance, estimate a gravity equation for
trade in financial assets, while Wei (2000), Evenett (2003), and Buch, Kleinert,
and Toubal (2004) use the gravity model to explain FDI f lows. In a recent study,
Di Giovanni (2005) applies the gravity model to the volume of cross-border
mergers and acquisitions.
A. Estimating Equation
We apply the gravity model to estimate the impact of international double tax-
ation on bilateral aggregate numbers of inward and outward M&As. Aggregate
numbers of this kind ref lect the direction of M&As between any two countries,
as considered before, and in addition the total number of M&As between the
two countries. In practice, there are no M&As for some country pairs. To cap-
ture this fact, we estimate a Tobit censored regression model of the following
kind:

=0 if M Aij∗ t < 0
M Aij t (6)
= exp(M Aij∗ t ) if M Aij∗ t ≥ 0 ,
where MAijt is the number of M&As at time t, with i and j denoting the acquiring
and target countries, and where MA∗ijt is an index function given by
M Aij∗ t = β0 + β xij t + ij t . (7)
In (6), xijt is a set of explanatory variables, β 0 and β are parameters to be esti-

mated, and ijt is a normally distributed error term. The main variable of inter-
est as part of xijt is the double tax rate τijt
double
. Higher double taxation imposed
by country i on the foreign-source income of local parent firms is expected to
lead to fewer M&As where this country is the acquiring country. Next, Dij τijt double
is the interaction of a dummy variable Dij signaling deferral of country i’s tax-
ation of income from country j and the double tax rate τijt double
. International
double taxation is expected to affect aggregate M&As less negatively if it can
be deferred. We also include the acquiring and target country tax rates τ it and
τ jt . Taxation in both countries may discourage the formation of multinationals
operating in the two countries. Among the non-tax controls, we include stan-
dard gravity model variables such as the bilateral distance, Distij , and the two
countries’ GDPs, GDPit and GDPjt . These variables, as are the other controls
apart from the categorical variables, are in logarithm. Additional explanatory
variables are the parent and subsidiary countries’ per capita GDP, denoted
GDPpercapit and GDPpercapjt . Multinational firms often have parent firms in
rich countries, which suggests a positive effect for GDPpercapit . At the same
time, multinational firms may wish to acquire targets in low-wage countries to
have access to cheap labor or in high-wage countries to have access to skilled
labor and interesting product markets. Hence, the impact of target country per
capita GDP, GDPpercapjt , can possibly have either sign.
Table VIII
Summary Statistics for the Gravity Model
The summary statistics relate to the variables used in the estimation of the gravity model of M&As.
For variable definitions and data sources, see the Appendix.
Variable Obs Mean Std. Dev Min Max
MAijt 8,042 3.51 13.14 0.00 364.00

τijt
double 8,042 5.35 6.29 0.00 42.00
Dij τijt
double 8,042 4.98 6.12 0.00 40.40
τ it 8,042 35.38 9.36 0.00 61.80
τ jt 8,042 35.70 8.87 0.00 65.00
Distanceij 8,042 6.93 0.91 4.37 8.82
GDPit 8,042 12.25 1.88 8.45 16.03
GDPjt 8,042 12.18 1.92 8.31 16.03
GDPpercapit 8,042 9.73 0.94 7.29 10.99
GDPpercapjt 8,042 9.73 0.97 7.24 10.99
(Stocks/GDP)it−1 8,042 −1.08 1.19 −6.43 1.70
(Credit/GDP)it−1 8,042 −0.40 0.73 −2.64 0.71
Exch.rateijt−1 8,042 0.00 0.16 −1.45 1.45

Tariffsjt 8,042 1.58 0.79 −4.09 3.10
Controlsjt 8,042 3.08 2.49 0.00 10.00
Borderij 8,042 0.10 0.30 0.00 1.00
Languageij 8,042 0.05 0.22 0.00 1.00
EUijt 8,042 0.28 0.45 0.00 1.00
Legalqualityjt 8,042 7.86 1.19 4.50 9.60
Next, parent country financial development variables such as stock market

valuation over GDP, (Stocks/GDP)it−1 , and credit provision to the private sector
over GDP, (Credit/GDP)it−1 , are expected to have a positive impact on acquisi-
tions. Following Di Giovanni (2005), we lag these financial depth variables by
one period to avoid endogeneity. The rate of appreciation of country i’s bilat-
eral real exchange rate with respect to country j,
Exch.rateijt−1 , is expected to
promote acquisitions in country j as this country’s assets have become cheaper.
The mean tariff rate in the target country, Tariffsjt , could similarly have a pos-
itive impact on acquisitions in that country if multinationals wish to “jump” a
country’s tariffs. An index counting the types of capital controls in the target
country, Controlsjt , may negatively impact acquisitions, as they may prevent
foreign investors from acquiring local companies. The variables Borderij and
Languageij denote a common border and language and they are both expected
to have a positive impact on bilateral acquisitions. The EUijt variable denotes
joint membership in the EU, which is also expected to foster acquisitions. Next,
Legalqualityjt measures the quality of the legal structure and the security of
property rights in the target country. We expect this variable to have a positive
impact on acquisitions in the target country, as it signals some protection from
expropriation and other unreasonable treatment. Table VIII provides summary
statistics for all these variables. Finally, the regressions contain dummy vari-
ables for acquiring and target countries and for time.
B. Estimation Results
Table IX reports regressions explaining the logarithm of the bilateral num-
ber of M&As, MAijt , resulting in parent and subsidiary firms in countries i and
j, respectively. Regression (1) shows a significant coefficient of −0.017 on the
double tax rate variable τijt
double
. This estimate suggests that an increase in the
double tax rate by one percentage point reduces the number of foreign acquisi-
tions by 1.7%.15 The acquiring and target country tax rates, τ it and τ jt , both take
negative coefficients, but only the latter coefficient is statistically significant.
The various control variables enter the regression largely as expected. Distance
has a negative impact on the number of cross-border acquisitions. The GDPs
of the acquiring and target countries enter with positive coefficients that are
not statistically significant in this regression, which includes country dummy
variables. Stock market capitalization in the acquiring country has a positive
and statistically significant impact on the number of acquisitions, as does the
target country tariff variable. A shared border and a common language also are
positively and significantly related to the number of acquisitions.
In regression (2) we include the double tax rate interacted with a deferral
dummy. This variable takes a positive coefficient, but is statistically insignifi-
cant. This may ref lect that the deferral option is not very valuable to merging
firms, or alternatively that our deferral variable measures the expected avail-
ability of deferral imprecisely.
In regression (3), we include the legal quality variable.16 The regression
shows that target country legal quality is significantly positively related to
the number of acquisitions with no change in the estimated coefficient on the
double tax variable. Regression (4) uses a τijtdouble
variable constructed on the as-
sumption that the newly created multinationals have an international branch
rather than subsidiary structure. The estimated coefficient on the double tax
variable is little changed. Regression (5) replaces the number of M&A deals by
the value of these deals. The estimated coefficients on the double tax variable
are now estimated to be −0.052, which is more negative than in regression
(1), suggesting that larger deals are relatively more affected by international
double taxation.
Next, we present several regressions that indicate the extent to which the
results are robust to changes in the estimation approach. First, regression (6) is
estimated by OLS using only uncensored observations with a positive number
of M&As. Disregarding censored observations should result in an attenuation
of coefficients; indeed, the estimated coefficient on the double tax rate variable
now is less negative at −0.009, but it remains significant. Second, regression
(7) assumes that the dependent variable yn is Poisson distributed such that
15
This is less than the 9.0% change reported in Section IV.B, but it should be kept in mind that
the 9.0% applies to the specific case of a merger of equals. Note that the estimate of 1.7% is an
upper bound given the Tobit specification.
16
The legal quality variable is not part of the benchmark regression because this variable is
computed differently before 1995. Furthermore, values between 1985 and 1990 and between 1990
and 1995 have been interpolated.
Table IX
Estimation Results for the Gravity Model of M&As
Unless indicated otherwise, these are Tobit regressions and the dependent variable is the logarithm
of the frequency of mergers and acquisitions in year t, in which the acquirer comes from country i and
the target comes from country j. Zero observations are taken into account as censored observations.
Regression (4) assumes that target firms are integrated as foreign branches. Regression (5) uses the
logarithm of the deal values of M&As as the dependent variable. Regression (6) is an OLS regression
using the uncensored observations (i.e., those with a positive number of M&As). Regression (7) is
a Poisson regression using the number of M&As as the dependent variable. Regression (8) is a
negative binomial regression using the number of M&As as the dependent variable. Regression (9)
is a two-step instrumental variable Tobit regression, where τijt double , τ , and τ are instrumented
it jt
by their 1- and 2-year lagged values. Country and time fixed effects are not reported. The Wald
test of exogeneity has as null hypothesis that the variables τijt double , τ , and τ are exogenous.
it jt
With a χ 2 statistic of 0.53 and p-value of 0.91, this hypothesis cannot be rejected. The test of
the overidentifying restrictions has an Amemiya-Lee-Newey minimum χ 2 statistic of 6.08 and a p-
value of 0.11. The hypothesis that the instruments are valid cannot be rejected. Standard errors are
provided in parentheses. Stars indicate the significance level: ∗ : 5%, ∗∗ : 1%. For variable definitions
and data sources, see the Appendix.
(1) (2) (3) (4)

Benchmark Deferral Legal Quality Branches
τijt
double −0.017∗∗ −0.024∗∗ −0.017∗∗ −0.018∗∗
(0.004) (0.006) (0.004) (0.004)
Dij τijt
double 0.008
(0.006)
τ it −0.003 −0.003 −0.003 0.001
(0.003) (0.003) (0.003) (0.003)
τ jt −0.019∗∗ −0.019∗∗ −0.018∗∗ −0.019∗∗
(0.003) (0.003) (0.003) (0.003)
Distanceij −0.967∗∗ −0.964∗∗ −0.970∗∗ −0.955∗∗
(0.037) (0.037) (0.037) (0.036)
GDPit 0.553 0.732 0.564 0.553
(0.957) (0.966) (0.957) (0.920)
GDPjt 1.394 1.370 1.142 0.801
(0.874) (0.873) (0.880) (0.857)
GDPpercapit 1.236 1.043 1.205 1.236
(1.084) (1.092) (1.083) (1.037)
GDPpercapjt −1.209 −1.170 −0.916 −0.595
(0.935) (0.935) (0.943) (0.915)
(Stocks/GDP)it−1 0.239∗∗ 0.236∗∗ 0.240∗∗ 0.236∗∗
(0.040) (0.040) (0.040) (0.039)
(Credit/GDP)it−1 0.151∗ 0.153∗ 0.151∗ 0.163∗∗
(0.061) (0.061) (0.061) (0.061)
Exch.rateijt−1 0.131 0.136 0.134 0.152

(0.094) (0.094) (0.094) (0.090)
Tariffsjt 0.197∗∗ 0.193∗∗ 0.209∗∗ 0.179∗∗
(0.059) (0.059) (0.059) (0.058)
Controlsjt −0.010 −0.010 −0.010 −0.004
(0.012) (0.012) (0.012) (0.011)
Borderij 0.154∗∗ 0.159∗∗ 0.151∗∗ 0.176∗∗
(0.055) (0.055) (0.055) (0.054)
Languageij 0.230∗∗ 0.231∗∗ 0.230∗∗ 0.246∗∗
(0.053) (0.053) (0.053) (0.052)
(continued)
Table IX—Continued
(1) (2) (3) (4)

Benchmark Deferral Legal Quality Branches
EUijt −0.049 −0.038 −0.056 0.007

(0.047) (0.047) (0.047) (0.045)
Legalqualityjt 0.102∗
(0.045)
N 8,042 8,042 8,042 8,845
Log-likelihood −5,110.6 −5,109.6 −5,108.0 −5411.7
(8)
(5) (6) (7) Negative (9)
Deal Values OLS Poisson Binomial IV
τijt
double −0.052∗∗ −0.009∗ −0.018∗∗ −0.025∗∗ −0.018∗∗
(0.016) (0.004) (0.005) (0.005) (0.004)
τ it 0.002 −0.001 −0.009∗ −0.005 −0.006
(0.014) (0.003) (0.004) (0.004) (0.005)
τ jt −0.074∗∗ −0.011∗∗ −0.017∗∗ −0.025∗∗ −0.023∗∗
(0.013) (0.003) (0.004) (0.004) (0.005)
Distanceij −2.647∗∗ −0.718∗∗ −0.881∗∗ −1.181∗∗ −0.942∗∗
(0.153) (0.038) (0.052) (0.048) (0.038)
GDPit 1.932 1.440 2.143∗ 1.365 1.034
(3.950) (1.069) (0.937) (1.066) (1.014)
GDPjt 8.365∗ 2.299∗ 0.379 1.821 2.714∗∗
(3.659) (1.011) (1.145) (1.032) (0.952)
GDPpercapit 2.502 −0.530 0.067 0.798 0.649
(4.546) (1.204) (1.075) (1.226) (1.165)
GDPpercapjt −8.493∗ −2.618∗ 0.557 −1.341 −2.981∗∗
(3.983) (1.070) (1.267) (1.125) (1.042)
(Stocks/GDP)it−1 0.639∗∗ 0.243∗∗ 0.664∗∗ 0.454∗∗ 0.282∗∗
(0.174) (0.046) (0.074) (0.055) (0.043)
(Credit/GDP)it−1 0.338 0.102 0.230∗ 0.208∗∗ 0.162∗
(0.269) (0.062) (0.091) (0.081) (0.063)
Exch.rateijt−1 0.375 0.104 0.114 0.160 0.082

(0.385) (0.109) (0.139) (0.118) (0.155)
Tariffsjt 0.639∗ 0.129∗ 0.173 0.223∗∗ 0.141∗
(0.259) (0.062) (0.088) (0.080) (0.063)
Controlsjt −0.089 0.010 0.001 −0.014 −0.008
(0.050) (0.011) (0.013) (0.013) (0.012)
Borderij 0.157 0.104 0.147∗ 0.139∗ 0.180∗∗
(0.236) (0.055) (0.058) (0.061) (0.057)
Languageij 0.289 0.255∗∗ 0.612∗∗ 0.271∗∗ 0.213∗∗
(0.218) (0.057) (0.048) (0.054) (0.053)
EUijt −0.175 −0.096∗ −0.106 −0.122∗ −0.059
(0.198) (0.049) (0.060) (0.053) (0.048)
Wald test: 0.53/0.91
Overid. test: 6.08/0.11
N 6,873 3,339 8,042 8,042 7,100
Log-likelihood/R2 −6,253.9 0.656 −1,1691.8 −9,969.3 n.a.
−λn yn
Prob (Yn = y n ) = exp yn ! λn for yn = 0, 1, 2, . . . with ln (λn ) = β xn . Again, the es-
timated coefficient on the double tax variable is negative at −0.018 and sta-
tistically significant. Regression (8) generalizes the previous one by assuming
that the dependent variable is distributed according to the negative binomial
distribution and obtains similar results.
As discussed in Section IV.B, there is a possibility that tax policy is endoge-
nous to the international pattern of M&As. In fact, changes in this pattern may
prompt countries to change their tax policies to affect the number of M&As
they are involved in as acquiring or target countries. Hence, τijt double
, τit , and τ jt
are potentially endogenous to the number of observed M&As. To adjust for this,
we instrument these variables by their 1- and 2-year lagged values in a two-
step instrumental variable Tobit regression.17 Standard errors are adjusted for
variation from the first-step regression. The double tax variable now takes a
statistically significant coefficient of −0.018 in regression (9). A Wald test of
the hypothesis that τijtdouble
, τit , and τ jt are exogenous cannot be rejected. Simi-
larly, a test of the hypothesis that the instruments are valid cannot be rejected.
Overall, this section’s results show that international double taxation has a sig-
nificant impact on parent firm location at the aggregate, national level. These
results are robust to various changes in model specification and estimation
technique.
VII. Conclusion
This paper shows that the international tax system affects the organiza-
tional outcomes of cross-border takeovers. Countries that impose high levels of
international double taxation are less likely to attract the parent companies
of newly created multinational firms. The organizational structure of multina-
tional firms, of course, has important non-tax as well as tax implications. Specif-
ically, the international organization of the firm implies cross-border relation-
ships of ownership and control that are bound to affect the internal operation
of the firm and the dealings of the firm with the affected national economies,
for instance, in the form of employment. The sensitivity of organizational out-
comes of cross-border takeovers to international double taxation suggests that
this taxation may carry significant economic costs in distorting international
relationships of ownership and control.
International double taxation comes in the form of nonresident dividend
withholding taxes and parent country corporate income taxation of repatriated
dividends. To reduce the potential for international double taxation to distort
organizational structures, both forms of international double taxation should
be lowered or eliminated. Nonresident dividend withholding taxes are already
quite low for most countries in our sample due to the EU Parent-Subsidiary
Directive. This directive, adopted in 1990, eliminates the taxation of intra-EU,
intra-company dividend f lows. Parent country corporate taxation of foreign-
source income, however, is still substantial in the EU and elsewhere. The United
17
For further details on the instrumental variable estimation, see the Internet Appendix.
States, for example, maintains a system of worldwide taxation applied to the

foreign-source income of U.S. multinationals. Recently, the President’s Advisory
Panel of Federal Tax Reform (2005) has advocated the elimination of worldwide
taxation by the United States. Simulations presented in this paper suggest that
the impact of such policy reform on the international patterns of parent country
selection could be economically significant. We estimate that the proportion of
U.S.-related cross-border takeovers resulting in an American parent company
would increase from 53% to 58%. This figure is calculated based on the premise
that systems of international taxation in other countries remain unchanged. A
more general abandonment of worldwide taxation would, of course, give rise to
a smaller redistribution of parent companies toward the United States, even if
it would further reduce the potential for the international tax system to distort
the parent company location choice.
Appendix: Variable Definitions and Data Sources
Variable Description and Data Source
θ double Difference between firms’ double tax burden rates in percent after acquiring
the other firm. The double tax burden is the additional double tax liability
divided by the two firms’ combined pre-tax income. The variable is
measured in percentage points. Sources for corporate income tax rates:
Chennells and Griffith (1997), Eurostat (2004), and KPMG International
Tax and Legal Center (2003). Sources for tax regimes, tax treaties, and
withholding taxes: Coopers & Lybrand (1998) and IBFD (2005a, 2005b,
2005c, 2005d). Previous issues of these publications were consulted as
well. Sources for financial information: Thomson Financial’s SDC
Database, Compustat Global, and Compustat North America.
θ double,d The part of

θ double that can be deferred in the case of non-repatriation of
subsidiary profits. Sources as for the variable
θ double above.
Size Difference in firms’ assets divided by the sum of the merging firms’ total
assets in millions of U.S. dollars. Sources: Thomson Financial’s SDC
Database, Compustat Global, and Compustat North America.
Liquidity Difference in firms’ liquidity ratios (liquid assets/total assets). Sources:

Thomson Financial’s SDC Database, Compustat Global, and Compustat
North America.
Leverage Difference in firms’ leverage ratios (total liabilities/total assets). Sources:

North America.
Fixedassets Difference in the firms’ ratios of fixed assets over total assets. Sources:
North America.
ROA Difference in firms’ profitability (net income / total assets). Sources: Thomson
Financial’s SDC Database, Compustat Global, and Compustat North
America.
Taxrate Difference in corporate income tax rates of the two countries. Sources:
Chennells and Griffith (1997), Eurostat (2004), and KPMG International
Tax and Legal Center (2003).
Stockmarket Difference in stock market capitalizations of the two countries relative to the
sum of the countries’ stock market capitalizations lagged by 1 year. Source:
World Development Indicators 2004, Worldbank (2004).
(continued)
Appendix—Continued
Credit Difference in domestic credit to the private sector of the two countries divided
by the summed volume of credit provision lagged by 1 year. Source: World
Development Indicators 2004, Worldbank (2004).
Exch. rate Difference in the two countries’ changes of the real bilateral exchange rate in
percentage points lagged by 1 year. Source: International Financial
Statistics 2007, IMF (2007).
Pretaxinc Difference in firms’ pre-tax incomes divided by the sum of pre-tax income in
millions of U.S. dollars, where nonpositive values of pre-tax income are
replaced by 0.001 to avoid low values in the denominator. Sources:
North America.
Investment Difference in firms’ investment activities as measured by the (negative) ratio

of net cash f low from investment activities to total assets. A negative cash
f low indicates a positive investment activity. Sources: Thomson Financial’s
SDC Database, Compustat Global, and Compustat North America.
MAijt Frequency of cross-border mergers and acquisitions in the year t, in which the
acquiring firm is located in country i and the target firm is located in
country j. A transaction is included if the bidding firm acquires a
controlling stake in the target firm. Source: Thomson Financial’s SDC
Database.
τijt
double Double tax rate for dividend income repatriated from country j to country i in
year t. This rate includes the burden of withholding taxes. Sources as for
the variable
θ double above.
Dij Dummy variable indicating potential deferral granted by acquiring country i
of taxes on subsidiary’s profits in country j. Data are for 2004. Sources as
for the variable
θ double above.
τ it Corporate income tax rate in the acquiring country i. Sources as for the
variable
θ double above.
τ jt Corporate income tax rate in the target country j. Sources as for the variable

θ double above.
Distanceij Distance in miles between the capital of acquiring firms’ country i and the
capital of target firms’ country j (logarithm). Source: Rose (2000).
GDPit Gross domestic product of the acquiring country in constant 1995 U.S. dollars
(logarithm). Source: World Development Indicators 2004, Worldbank
(2004).
GDPjt Gross domestic product of the target country in constant 1995 U.S. dollars
(2004).
GDPpercapit Income per capita of the acquiring country (logarithm). Source: World
GDPpercapjt Income per capita of the target country (logarithm). Source: World
(Stocks/GDP)it−1 Ratio of stock market capitalization to GDP of the acquiring country
(2004).
(Credit/GDP)it−1 Ratio of domestic credit to the private sector to GDP of the acquiring country
(2004).
(continued)
Appendix—Continued
Exch.rateijt−1 Change in the logarithm of the real bilateral exchange rate between countries
i and j between year t − 1 and year t − 2. Source: International Financial
Statistics 2007, IMF (2007).
Tariffsjt Mean tariff rate of target country (logarithm). Source: Gwartney and Lawson
(2005).
Controlsjt Index of the number of capital controls in the target country based on 13 types
of capital controls reported by the IMF. The original index is inverted such
that a higher index corresponds to more capital controls. Source: Gwartney
and Lawson (2005).
Borderij Dummy variable indicating whether acquiring country i and target country j
have a common land border. Source: Rose (2000).
Languageij Dummy variable indicating whether acquiring country i and target country j
share a common language. Source: Rose (2000).
EUijt Dummy variable indicating whether acquiring country i and target country j
were both members of the European Union in year t. Source: Rose (2000).
Legalqualityjt Indicator for the quality of legal structure and the security of property rights
in the target country. The definition of the variable was broadened in 1995.
Values between 1985 and 1990 and between 1990 and 1995 have been
interpolated. Source: Gwartney and Lawson (2005).
REFERENCES
Altshuler, Rosanne, Harry Grubert, and T. Scott Newlon, 2001, Has U.S. investment abroad become
more sensitive to tax rates? in James R. Hines, Jr., ed.: International Taxation and Multina-
tional Activity (University of Chicago Press, Chicago).
Ayers, Benjamin C., Craig E. Lefanowicz, and John R. Robinson, 2003, Shareholder taxes in acqui-
sition premiums: The effect of capital gains taxation, Journal of Finance 58, 2783–2801.
Blonigen, Bruce A., 1997, Firm-specific assets and the link between exchange rates and foreign
direct investment, American Economic Review 87, 447–465.
Bogenschütz, Eugen, and Kelly Wright, 2000, Daimler-Chrysler merger, International Tax Review,
February issue.
Boskin, Michael J., and William G. Gale, 1987, New results on the effects of tax policy on the
international location of investment, in Martin Feldstein, ed.: The Effects of Taxation on Capital
Accumulation (University of Chicago Press, Chicago).
Bris, Arturo, and Christos Cabolis, 2008, The value of investor protection: Firm evidence from
cross-border mergers, Review of Financial Studies 21, 605–648.
Buch, Claudia M., Jorn Kleinert, and Farid Toubal, 2004, The distance puzzle: On the interpretation
of the distance coefficient in gravity equations, Economics Letters 83, 293–298.
Chamberlain, Gary, 1980, Analysis of covariance with qualitative data, Review of Economic Studies
47, 225–238.
Chennells, Lucy, and Rachel Griffith, 1997, Taxing Profits in a Changing World (The Institute for
Fiscal Studies, London).
Comment, Robert, and G. William Schwert, 1995, Poison or placebo? Evidence on the deterrence
and wealth effects of modern antitakeover measures, Journal of Financial Economics 39, 3–43.
Coopers & Lybrand, 1998, International Tax Summaries: A Guide to Planning and Decisions (1985–
1998) (John Wiley & Sons, Chichester).
Desai, Mihir A., and James R. Hines, Jr., 2002, Expectations and expatriations: Tracing the causes
and consequences of corporate inversions, National Tax Journal 55, 409–440.
Desai, Mihir A., and James R. Hines, Jr., 2004, Old rules and new realities: Corporate tax policy
in a global setting, National Tax Journal 55, 937–960.
Devereux, Michael P., and Rachel Griffith, 1998, Taxes and the location of production:
Evidence from a panel of U.S. multinationals, Journal of Public Economics 68, 335–
367.
Di Giovanni, Julian, 2005, What drives capital f lows? The case of cross-border M&A activity and
financial deepening, Journal of International Economics 65, 127–149.
Dyck, Alexander, and Luigi Zingales, 2004, Private benefits of control: An international comparison,
Journal of Finance 59, 537–600.
Eurostat, 2004, Structures of the Taxation Systems in the European Union (Office for Official Pub-
lications of the European Communities, Luxembourg).
Evenett, Simon J., 2003, Do all networks facilitate international commerce? U.S. law firms and
the international market for corporate control, Journal of the Japanese and International
Economies 17, 520–537.
Greene, William H., 2008, Econometric Analysis (Prentice-Hall, Upper Saddle River, NJ).
Grubert, Harry, and John H. Mutti, 1991, Taxes, tariffs and transfer pricing in multinational
company decision making, Review of Economics and Statistics 73, 285–293.
Gwartney, James D., and Robert A. Lawson, 2005, Economic Freedom of the World: 2005 Annual
Report (The Fraser Institute, Vancouver).
Hartman, David G., 1984, Tax policy and foreign direct investment in the United States, National
Tax Journal 37, 475–487.
Hines, Jr., James R., 1994, Credit and deferral as international investment incentives, Journal of
Public Economics 55, 323–347.
Hines, Jr., James R., 1996, Altered states: Taxes and the location of foreign direct investment in
America, American Economic Review 86, 1076–1094.
Hines, Jr., James R., and Eric M. Rice, 1994, Fiscal paradise: Foreign tax havens and American
business, Quarterly Journal of Economics 109, 149–182.
International Bureau of Fiscal Documentation (IBFD), 2005a, Corporate Investment Income (IBFD
Publications, Amsterdam).
International Bureau of Fiscal Documentation (IBFD), 2005b, Corporate Taxation in Europe (IBFD
International Bureau of Fiscal Documentation (IBFD), 2005c, IBFD Tax Treaties Database (IBFD
International Bureau of Fiscal Documentation (IBFD), 2005d, Taxation & Investment in Central
and Eastern European Countries (IBFD Publications, Amsterdam).
International Monetary Fund (IMF), 2007, International Financial Statistics (IMF, Washington,
DC).
KPMG International Tax and Legal Center, 2003, KPMG’s Corporate Tax Rate Survey 1998–2003
(KPMG International).
La Porta, Rafael, Florencio Lopez de Silanes, Andrei Shleifer, and Robert W. Vishny, 2002, Investor
protection and corporate valuation, Journal of Finance 57, 1147–1170.
McFadden, Daniel, 1973, Conditional logit analysis of qualitative choice behavior, in Paul
Zarembka, ed.: Frontiers in Econometrics (Academic Press, New York).
Mitchell, Mark L., and J. Harold Mulherin, 1996, The impact of industry shocks on takeover and
restructuring activity, Journal of Financial Economics 41, 193–230.
Newlon, T. Scott, 1987, Tax policy and the multinational firm’s financial policy and investment
decisions, Ph.D. dissertation, Princeton University.
Organisation for Economic Co-operation and Development (OECD), 2005, Model Tax Convention
on Income and on Capital (OECD, Paris).
Portes, Richard, and Helene Rey, 2005, The determinants of cross-border equity f lows, Journal of
International Economics 65, 269–296.
President’s Advisory Panel on Federal Tax Reform, 2005, Simple, Fair & Pro-Growth: Proposals to
Fix America’s Tax System (U.S. Government Printing Office, Washington, DC).
Rajan, Raghuram G., and Luigi Zingales, 1995, What do we know about capital structure? Some
evidence from international data, Journal of Finance 50, 1421–1460.
Rose, Andrew K., 2000, One money, one market: Estimating the effect of common currencies on
trade, Economic Policy 15, 8–45.
Rossi, Stefano, and Paolo F. Volpin, 2004, Cross-country determinants of mergers and acquisitions,
Journal of Financial Economics 74, 277–304.
Slemrod, Joel, 1990, Tax effects on foreign direct investment in the United States: Evidence from
a cross-country comparison, in Assaf Razin, and Joel Slemrod, eds.: Taxation in the Global
Economy (University of Chicago Press, Chicago).
United Nations Conference on Trade and Development, 2000, World Investment Report 2000: Cross-
border Acquisitions and Development (United Nations, New York and Geneva).
United Nations Conference on Trade and Development, 2005, World Investment Report 2005:
Transnational Corporations and the Internationalization of R&D (United Nations, New York
and Geneva).
Wei, Shang-Jin, 2000, How taxing is corruption on international investors? Review of Economics
and Statistics 82, 1–11.
Worldbank, 2004, World Development Indicators (Worldbank, Washington, DC).
Young, Kan H., 1988, The effects of taxes and rates of return on foreign direct investment in the
United States, National Tax Journal 41, 109–121.

International Taxation and The Direction and Volume of Cross-Border M&As

Uploaded by

Copyright:

Available Formats

International Taxation and The Direction and Volume of Cross-Border M&As

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

International Taxation and The Direction and Volume of Cross-Border M&As

Uploaded by

Copyright:

Available Formats

THE JOURNAL OF FINANCE • VOL. LXIV, NO.

International Taxation and the Direction

HARRY P. HUIZINGA and JOHANNES VOGET∗

A MULTINATIONAL TYPICALLY has a parent firm in one country and subsidiaries

U.S. According to testimony given by Daimler-Chrysler’s chief tax counsel before

Slemrod (1990) and Hines (1996) recognize the importance of international

II. The International Tax System

Tax Rate With Tax Treaty Without Tax Treaty

Austria 34.0 Exemption Exemption

In practice, most countries provide some form of international double tax

Form of Double Tax Relief Condition Double Tax Rate τijdouble

parent country taxation. Alternatively, the parent country operates a world-

III. M&A Data and International Double Taxation

Dividends Received Dividends Paid

τ̄id oubl e Corei Whti τ̄ dj oubl e Corej Whtj

Netherlands 1.3 0.0 1.3 1.3 0.6 0.9

Number of Number of Value of Acquisitions Value of Target

Austria 624 552 10,947 19,399

tax rate τijdouble if the acquiring firm’s income is negative.9 Straightforwardly,

Distribution of Double Tax Liability Rates

Thompson database. To expand our sample, we obtain additional information

IV. The Direction of M&As

on a broader definition of foreign profit under some circumstances. Detailed

Stockmarket is expected to have a positive sign. As in Di Giovanni (2005), the

Variable Obs Mean Std. Dev Min Max

y 917 1.00 0.00 1.00 1.00

θ double 917 −1.50 4.65 −30.00 27.50

θ double,d 582 −0.51 1.65 −16.30 5.80

Size 917 0.70 0.36 −0.99 0.99

Liquidity 582 0.00 0.20 −0.82 1.55

Leverage 582 −0.02 0.51 −5.36 3.18

Fixedassets 394 −0.16 0.19 −0.88 0.66

ROA 582 0.08 0.35 −1.18 3.01

Taxrate 582 0.42 10.09 −30.00 30.00

Stockmarket 582 −0.01 0.73 −0.99 0.99

Credit 582 −0.01 0.72 −0.99 0.99

Exch.rate 582 −0.02 0.18 −0.45 0.50

Pretaxinc 582 0.58 0.56 −1.00 1.00

Investment 346 0.05 0.22 −0.80 1.09

(1) (2) (3) (4) (5)

θ double −0.358∗∗ −0.357∗∗ −0.263∗ −0.501∗∗ −0.498∗∗

Size 5.698∗∗ 5.696∗∗ 5.453∗∗ 7.412∗∗ 10.397∗∗

Liquidity 3.160∗ 3.154∗ 2.950∗ 6.726∗∗ 3.252

Leverage 0.852∗ 0.850∗ 0.825 2.168

ROA −0.360 −0.359 −0.583 −0.449 −0.286

Taxrate 0.091 0.090 0.069 0.192 0.328∗∗

Stockmarket 1.420 1.403 0.943 −1.685 4.089

Credit −5.243 −5.217 −4.942 −3.041 −12.645∗

Exch. rate −1.659 −1.650 −1.827 −1.694 −4.694

(6) (7) (8) (9) (10)

θ double −0.186∗∗ −0.355∗∗ −0.340∗∗ −0.322∗∗ −0.190∗∗

Size 2.978∗∗ 5.730∗∗ 5.399∗∗ 5.380∗∗ 2.893∗∗

Liquidity 1.545∗ 3.189∗ 2.899∗ 3.616∗∗ 1.510∗

Leverage 0.372 0.877∗ 0.902∗ 0.782 0.376

ROA −0.259 −0.321 −0.268 −0.598 −0.294

Taxrate 0.046 0.100 0.089 0.220∗∗ 0.048

Stockmarket 0.762 1.167 3.025 −3.448 0.729

Credit −2.939 −5.069 −6.221 −29.024∗∗ −2.731

Exch. rate −1.138 −1.793 −1.879 −0.324 −0.991