The Effects of the Cost of Foreign Internal Funds on the Probability That a Firm Issues Domestic Debt

Abstract

This paper investigates whether U.S. multinational firms' use of domestic debt to fund investments depends upon their cost of foreign internal funds. The pecking order theory predicts that firms should generally prefer internal funds as a financing source over debt. Holding total internal funds constant, I investigate an exception to this general relation by examining whether firms are more likely to issue domestic debt as the tax cost of their foreign internal funds increases. Using a sample of 268 firmyears, I find that the probability of firms with non-binding foreign tax credit limitations using domestic debt relates positively to their permanently reinvested earnings. This finding contributes to the literature by suggesting that tax and financial reporting costs associated with foreign repatriations influence firms to forgo internal funds as a financing choice in favor of debt.