International Corporate Taxation and U.S. Multinationals’ Behavior: an Integrated Approach

Using data from the International Revenue Service, this paper explores the effcts of corporate taxation on U.S. capital invested abroad and on tax planning practices (dividend payments, income shifting, and passive investment). The econometric analysis first indicates that investment is strongly influenced by average tax rates, with a magnified impact for particularly low-tax rates implying that the attractiveness of low-tax countries is not weakened by anti-deferral rules and cross-crediting limitations. Further explorations suggest that firms report higher profit and are less likely to repatriate dividends when they are located in low-tax jurisdictions. Firms also report higher Subpart F income in countries in which they shift their profit, suggesting that cross-crediting provides an incentive to shift passive income in low-tax countries and that passive investment can be an alternative strategy to minimize taxes when active investment opportunities are lacking. Finally, the paper estimates the role of effective transfer pricing regulation on income shifting activities using the quality of host countries' law enforcement. It appears that low degrees of law enforcement are associated with higher income-shifting.

Discretionary Policy in a Monetary Union with Sovereign Debt

This paper examines the interactions between multiple national fiscal policy- makers and a single monetary policy maker in response to shocks to government debt in some or all of the countries of a monetary union. We assume that national governments respond to excess debt in an optimal manner, but that they do not have access to a commitment technology. This implies that national fi scal policy gradually reduces debt: the lack of a commitment technology precludes a random walk in steady state debt, but the need to maintain national competitiveness avoids excessively rapid debt reduction. If the central bank can commit, it adjusts its policies only slightly in response to higher debt, allowing national fiscal policy to undertake most of the adjustment. However if it cannot commit, then optimal monetary policy involves using interest rates to rapidly reduce debt, with signifi cant welfare costs. We show that in these circumstances the central bank would do better to ignore national fiscal policies in formulating its policy.

The EMU sovereign-debt crisis: Fundamentals, expectations and contagion

We offer a detailed empirical investigation of the European sovereign debt crisis based on the theoretical model by Arghyrou and Tsoukalas (2010). We find evidence of a marked shift in market pricing behaviour from a ‘convergence-trade’ model before August 2007 to one driven by macro-fundamentals and international risk thereafter. The majority of EMU countries have experienced contagion from Greece. There is no evidence of significant speculation effects originating from CDS markets. Finally, the escalation of the Greek debt crisis since November 2009 is confirmed as the result of an unfavourable shift in countryspecific market expectations. Our findings highlight the necessity of structural, competitiveness-inducing reforms in periphery EMU countries and institutional reforms at the EMU level enhancing intra-EMU economic monitoring and policy co-ordination.

Delay and Haircuts in Sovereign Debt: Recovery and Sustainability

One of the striking aspects of recent sovereign debt restructurings is, conditional on default, delay length is positively correlated with the size of haircut. In this paper, we develop an incomplete information model of debt restructuring where the prospect of uncertain economic recovery and the signalling about sustainability concerns together generate multi-period delay. The results from our analysis show that there is a correlation between delay length and size of haircut. Such results are supported by evidence. We show that Pareto ranking of equilibria, conditional on default, can be altered once we take into account the ex ante incentive of sovereign debtor. We use our results to evaluate proposals advocated to ensure orderly resolution of sovereign debt crises.

Does China overinvest? Evidence from a panel of Chinese firms

This paper addresses the hotly-debated question: do Chinese firms overinvest? A firm-level dataset of 100,000 firms over the period of 2000-07 is employed for this purpose. We initially calculate measures of investment efficiency, which is typically negatively associated with overinvestment. Despite wide disparities across various ownership groups, industries and regions, we find that corporate investment in China has become increasingly efficient over time. However, based on direct measures of overinvestment that we subsequently calculate, we find evidence of overinvestment for all types of firms, even in the most efficient and most profitable private sector. We find that the free cash flow hypothesis provides a good explanation for China‟s overinvestment, especially for the private sector, while in the state sector, overinvestment is attributable to the poor screening and monitoring of enterprises by banks.

The EMU sovereign-debt crisis: fundamentals, expectations and contagion

In a research project conducted while visiting the DG-ECFIN in June 2010, we provided a detailed empirical investigation of the EMU sovereign-debt crisis up to February 2010.

Indexed versus nominal government debt under inflation and price-level targeting

This paper presents a DSGE model in which long run inflation risk matters for social welfare. Optimal indexation of long-term government debt is studied under two monetary policy regimes: inflation targeting (IT) and price-level targeting (PT). Under IT, full indexation is optimal because long run inflation risk is substantial due to base-level drift, making indexed bonds a much better store of value than nominal bonds. Under PT, where long run inflation risk is largely eliminated, optimal indexation is substantially lower because nominal bonds become a better store of value relative to indexed bonds. These results are robust to the PT target horizon, imperfect credibility of PT and model calibration, but the assumption that indexation is lagged is crucial. From a policy perspective, a key finding is that accounting for optimal indexation has important welfare implications for comparisons of IT and PT.

The Inflation Risk Premium on Government Debt in an Overlapping Generations Model

This paper presents a general equilibrium model in which nominal government debt pays an inflation risk premium. The model predicts that the inflation risk premium will be higher in economies which are exposed to unanticipated inflation through nominal asset holdings. In particular, the inflation risk premium is higher when government debt is primarily nominal, steady-state inflation is low, and when cash and nominal debt account for a large fraction of consumers' retirement portfolios. These channels do not appear to have been highlighted in previous models or tested empirically. Numerical results suggest that the inflation risk premium is comparable in magnitude to standard representative agent models. These findings have implications for management of government debt, since the inflation risk premium makes it more costly for governments to borrow using nominal rather than indexed debt. Simulations of an extended model with Epstein-Zin preferences suggest that increasing the share of indexed debt would enable governments to permanently lower taxes by an amount that is quantitatively non-trivial.

Disputes, Debt and Equity

We show how the prospect of disputes over firms’ revenue reports promotes debt financing over equity. These findings are presented within a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive regimes which limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic enforcement strategies. Consequently, optimal contracts shift away from equity and toward standard debt. For a useful special case of the model, closed form solutions are presented for leverage and consumption allocations under efficient debt contracts.

Delay and Haircuts in Sovereign Debt: Recovery and Sustainability

One of the striking aspects of recent sovereign debt restructurings is, conditional on default, delay length is positively correlated with the size of "haircut", which is size of creditor losses. In this paper, we develop an incomplete information model of debt restructuring where the prospect of uncertain economic recovery and the signalling about sustainability concerns together generate multi-period delay. The results from our analysis show that there is a correlation between delay length and size of haircut. Such results are supported by evidence. We show that Pareto ranking of equilibria, conditional on default, can be altered once we take into account the ex ante incentive of sovereign debtor. We use our results to evaluate proposals advocated to ensure orderly resolution of sovereign debt crises.

The response of the external finance premium in Asian corporate bond markets to financial characteristics, financial constraints and two financial crises

Empirical investigation of the external finance premium has been conducted on the margin between internal finance and bank borrowing or equities but little attention has been given to corporate bonds, especially for the emerging Asian market. In this paper, we hypothesize that balance sheet indicators of creditworthiness could affect the external finance premium for bonds as they do for premia in other markets. Using bond-specific and firm-specific data for China, Hong Kong, Indonesia, Korea, Philippines, Singapore and Thailand during 1995-2009 we find that firms with better financial health face lower external finance premia in all countries. When we introduce firm-level heterogeneity, we show that financial variables appear to be both statistically and quantitatively more important for financially constrained firms. Finally, when we examine the effects of the 1997-98 Asian crisis and the 2007-09 global financial crisis, we find that the sensitivity of the premium is greater for constrained firms during the Asian crisis compared to other times.