Internal Debt Financing Research Articles

Optimal Financing Strategy in a Dual-Channel Supply Chain with Agricultural Product

This study models a two-stage agricultural supply chain consisting of a financially constrained manufacturer of agricultural products and a financially stable retailer. We examine two supply chain structures: traditional and dual channel. Our analysis centers on the effects of consumer green preferences, consumer sensitivity to the freshness of agricultural products, and substitution rate between green and non-green agricultural products on the profitability of supply chain members. The purpose of this work is to study the optimal financing strategy for companies producing both regular and organic products simultaneously. We analyze optimal financing strategies for the manufacturer using three models: bank financing, internal debt financing, and internal equity financing. Our results indicate that in both traditional and dual-channel supply chains, increased consumer green preferences or greater sensitivity to the freshness of agricultural products improve supply chain profitability, while a higher substitution rate between green and non-green products reduces profits. Additionally, the manufacturer prefers internal debt financing when consumer environmental awareness is low. Conversely, as consumer environmental awareness increases, internal equity financing becomes more profitable. These findings offer valuable insights for agricultural product manufacturers facing financial constraints, assisting them in selecting the most appropriate financing model.

Internal debt and welfare

AbstractThis paper analyzes how multinational firms' internal debt financing affects high‐tax countries. It uses a dynamic small open economy model and takes into account that internal debt impacts both the multinational firms' investment decisions and the government's tax policy. The government has incentives to redistribute income from firm owners to workers. If the government's redistributive motive is not too strong, internal debt reduces welfare in the short term by decreasing tax revenues. However, debt financing stimulates capital accumulation and exerts a positive long‐term welfare impact.

Corporate Debt Mix and Long-term Firm Growth in Japan

ABSTRACT This paper examines how firms change debt financing channels in line with the development of financial markets. In this aim, a data set of Japanese listed firms from 1965 (with more than 10% of annual GDP growth) to 2015 (almost 0% GDP growth) is used. We find a long-term change in the debt mix from internal debt financing (e.g., trade credits) to external debt financing (e.g., public bonds). Furthermore, we document that the firm growth rate is positively related to bond financing and negatively associated with trade credits. These associations are not conditional on interlocking business relationships with Keiretsu. The findings imply that the role of established firms’ internal financing channels diminishes as financial markets develop along with economic growth.

Not All Profit Shifting is Created Equal? An Analysis of Internal Debt

This paper analyzes how internal debt financing of multinational firms affects high-tax countries. It uses a dynamic small open economy model and takes into account that internal debt impacts both the multinational firms’ investment decisions and the government's tax policy. The government has incentives to redistribute income from firm owners to workers. If the government’s redistributive motive is not too strong, internal debt reduces welfare in the short term by decreasing tax revenues. However, debt financing stimulates capital accumulation and exerts a positive long term welfare impact. If the multinational firm additionally manipulates transfer prices, the adverse short term welfare effects may extend to the long term.

Safe haven or earnings stripping rules: a prisoner’s dilemma?

Multinational firms use internal debt financing to shift profits from high-tax to low-tax countries. Therefore, governments restrict the deductibility of interest expenses by applying thin-capitalization rules (TCRs). TCRs fall into two main categories: safe haven rules (SHR) and earnings stripping rules (ESR). We analyze the optimal TCR choice in a two-country tax competition model. We show that unilateral replacement of SHR by ESR imposes a negative profit shifting externality on the other country. This effect can explain the recently observed switch from SHR to ESR in many countries. However, ESR may be a dominant strategy even when SHR is socially optimal, i.e., the observed policies of ESR implementation may indicate a prisoner’s dilemma.

Earnings quality and managerial access to debt financing: empirical evidence from Iran

PurposeThe purpose of this paper is to establish a linkage between two rarely researched areas, i.e. earnings quality (EQ) and access to external and internal debt financing. Specifically, the authors aim to examine whether the quality of a firm’s reported earnings is significantly associated with its access to both private and bank debt financing.Design/methodology/approachThe authors test the hypotheses by employing panel data analysis for a sample of 108 companies listed on the Tehran Stock Exchange (TSE) during 2006-2015. The tests were conducted by using R econometric software.FindingsAfter controlling for some firm-specific factors and consistent with the primary expectations, the results reveal a significant and positive relationship between EQ and managerial access to external (bank) debt financing. In addition, the findings indicate that EQ is negatively associated with internal debt financing which is measured as the changes in firm retained earnings.Research limitations/implicationsAlthough the authors cautiously conducted the present study, there are some limitations that merit further consideration. First, the authors collected the data manually from 14 categories of industries in the TSE and, accordingly, an aggregate analysis across multiple categories of industries might have missed industry-specific and unique issues. Second, the authors used a narrow conceptualization of accruals quality which merely assesses a firm’s EQ. The measures can be enhanced by including more actionable proxies. Third, since the data on debt financing were collected from two different sources, this might have caused common method variance in the results procedurally.Originality/valueSince the fundamental institutional assumptions underpinning the Western and even East Asia debt contracting and EQ models are not valid in the institutional environment of Iran, the findings could provide substantial implications for the understanding of both debt financing and the quality of earnings. These significant institutional and ownership differences are the factors affecting firms’ leverage and capital choice decisions. Indeed, the study has laid some groundwork upon which a more detailed evaluation of the Iranian firms’ financial structure could be based.

Restricted interest deductibility and multinationals’ use of internal debt finance

This paper reconsiders the role of interest deductibility for internal debt financing of multinational corporations (MNCs). We provide quasi-experimental evidence using restrictions on interest deductibility through thin-capitalization rules. Explicitly distinguishing between firms subject to a binding restriction and unrestricted firms, a panel data sample selection model is used to explore the tax sensitivity of the capital structure of foreign subsidiaries of MNCs. Our results confirm that the tax incentive for using internal loans is effectively removed for restricted subsidiaries. While internal debt financing of unrestricted subsidiaries positively responds to taxes, the effects are relatively small.

The Impact of Thin‐Capitalization Rules on External Debt Usage – A Propensity Score Matching Approach

AbstractThin‐capitalization rules (TCRs) aim at limiting the tax advantage of internal debt financing by restricting the tax deductibility of the corresponding interest expenses. This article examines how subsidiaries of multinational firms respond to a change in the German thin‐capitalization legislation. The empirical analysis not only demonstrates that the TCR effectively restricts internal debt financing, it also suggests that firms are able to avoid taxation of interest by substituting external for internal debt. The empirical approach applies propensity score matching techniques and exploits the German tax reform 2001 to solve endogeneity problems.

Bilateral internal debt financing and tax planning of multinational firms

This paper examines how taxes affect bilateral internal debt financing among foreign entities of multinational firms. Our data allows us to construct precise bilateral tax-rate differentials between borrowers and lenders of internal debt, which are found to be positively related to internal debt financing of borrowing entities. Compared with previous studies, the estimated tax-elasticity of internal debt exceeds earlier findings by far, most probably accruing to the bilateral specification of tax incentives. Additional investigations on whether and to what extent countries effectively impose anti-tax-avoidance measures show that thin-capitalization rules in host countries are particularly effective.

Corporate Taxes and Internal Borrowing within Multinational Firms

This study develops a theoretical model of a multinational firm with an internal capital market. Hypotheses regarding the role of local versus foreign characteristics such as profit tax rates, lack of institutional quality, financial underdevelopment, and productivity for internal debt financing at the level of foreign affiliates are derived and assessed empirically in a panel dataset covering the universe of German multinationals. We show that differences in nontax incentives given by fundamentals in local and foreign markets can offset or reinforce tax incentives. The results point at a many times higher tax-sensitivity of internal debt financing compared to previous research. (JEL F23, G32, H25)

International Tax Law and the Multinational Capital Structure: Evidence from US MNCs German Direct Investment

Multinational financial decisions are a central aspect of multinational parent companies (MNCs) managerial strategy. Investments must be financed in some way. However, there are always financing alternatives that can be considered. International competitive strategies of managers involve cross-border complexities. Choices about investment, organizational and internal financial structure involve international considerations. How do tax considerations factor into MNCs management strategies and internal financial decision-making? In this regard, ( US) MNCs often use intra-group cross-border debt financing structures in order to optimize the effective tax rate (ETR) of high-taxed German affiliates. However, the new German thin capitalization (hereinafer 'thin cap') provision (German interest barrier) restricts this financial tax planning approach significantly. Currently, tax-effective income shifting from German subsidiaries to low-taxed intra-group finance companies by internal debt financing is limited to 30% of the taxable earnings before interest, tax, depreciation, and amortization (EBITDA) per fiscal year. Thus, the German thin cap provision has a major impact in terms of the value of the debt tax shield. Therefore, the way US MNCs configurate the entrepreneurial capital structure of German subsidiaries (equity versus debt capitalization) is extremely tax driven and affected by German thin cap rules. This paper shows a new and innovative tax-efficient internal debt financing structure for US MNCs that has been developed to optimize the net after-tax profits of German operative affiliates. This new and flexible internal financial structure allows US MNCs unlimited internal debt financing of German subsidiaries without the harmful effects of the German thin cap provision. However, the scope of the application of the new intra-group debt financing structure is not limited to US MNCs. This investment and financing structure is also of high importance for global investors engaged in direct investments in Germany.