Thesis (Selection of subject)Thesis (Selection of subject)(version: 336)
Assignment details
  
International taxation and cross-border mergers and acquisition
Thesis title in Czech: Mezinárodní zdanění a zahraniční fúze a akvizice
Thesis title in English: International taxation and cross-border mergers and acquisition
Key words: mergers and acqusitions, international taxation, foreign direct investments, profit shifting
English key words: mergers and acqusitions, international taxation, foreign direct investments, profit shifting
Academic year of topic announcement: 2015/2016
Type of assignment: diploma thesis
Thesis language: angličtina
Department: Institute of Economic Studies (23-IES)
Supervisor: doc. Petr Janský, M.Sc., Ph.D.
Author: hidden - assigned by the advisor
Date of registration: 17.06.2016
Date of assignment: 17.06.2016
Date and time of defence: 17.09.2019 09:00
Venue of defence: Opletalova - Opletalova 26, O206, Opletalova - místn. č. 206
Date of electronic submission:31.07.2019
Date of proceeded defence: 17.09.2019
Reviewers: PhDr. Jaromír Baxa, Ph.D.
 
 
 
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Guidelines
Motivation:
In November 2015, U.S. pharmaceutical giant Pfizer announced a merger with Ireland pharma company Allergan. The main and maybe also the only reason for this merger was a tax inversion of Pfizer from U.S. tax regime to the Ireland regime. Tax savings from repatriating retained offshore income were estimated up to 35 billion of USD (ATF 2015), if the deal would proceed. Additional tax benefits would certainly come from operating under new Ireland tax regime. Such huge tax benefits can also justify relatively high takeover premium that was 60% of unaffected Allergan value. This takeover finally collapse on the new U.S. regulation that puts certain obstacle for Pfizer to do so. Nevertheless, this was not the first attempt of Pfizer to do tax inversion (attempt with Astra Zeneca in past) and arguably neither the last one.
This motivates me to use data of cross-border M&As activity to study the effect of different tax regimes on market for corporate control. There are several studies suggesting that tax issues really matter in decisions about M&As. The common intuition is that companies shift their residence using M&As to the locations that provides some tax benefits compared to origin location. Scholes and Wolfson (1989) studied the effect of tax reforms in USA during 1980’s on market for corporate control and they found significant shift in demand for M&A. More recently, Huizinga and Voget (2009) studied how the double taxation regimes across European countries, USA and Japan determine the parent-subsidiary relation in multinational companies. Using M&A data they found that international double tax liability would increase by 1.5 p.p. of worldwide income if the parent-subsidiary structure would be inverted. Moreover, they found tax reasons to be significant driver in decision about parent location. Other studies showed that increase in local tax rate reduces the FDI (Hines and Rice 1994, Newlon 2001), nevertheless the M&A data as subset of FDI provides much more detailed information that can be studied to greater detail. Therefore, not only the magnitude and direction of M&As (as a substantial part of FDI) can be studied, but also the questions such as, whether, how much and under which condition are tax inversions profitable for companies, can be answered. The answers for latter questions can be substantial insight to issues of tax havens that become more and more discussed in past years.

Hypotheses:
1. Hypothesis #1: Difference in target’s and acquirer’s local corporate tax rates (double tax rates) positively affects the probability of being overtaken (direction).
2. Hypothesis #2: Difference in target’s and acquirer’s local corporate tax rates (double tax rates) positively affects the number of takeovers or total value of takeovers (volume).
3. Hypothesis #3: Difference in target’s and acquirer’s local corporate tax rates (double tax rates) positively affects the takeover premium and post-takeover performance of acquirer (profitability).

Methodology:
Detailed M&A data can be accessed from Thomson Reuters SDC database. Only the cross-border deals are in the merit of interest, nevertheless the non-cross-border takeovers can serve as control group for verifying the results. As the taxation is changing, the time span of cross-border deals should be limited (i.e. since 1990’s). Also the sample of countries has to be preselected depending on two constraints: a) availability of detailed data about tax regime, b) having sufficient number of takeovers within the sample for each country enabling to control for country-pairs fixed effect.
The corporate tax rates for each country can be set either in statutory way or as an average effective rates calculated in previous researches. Moreover, we can compute also directly from annual reports the effective tax rates of given company (target as well as acquirer), which is also the benefit of having micro data and not the aggregates of FDI. The starting point for detailed data about double taxation can be the paper of Huizinga and Voget (2009) that provides methodology of calculation and also the data for 28 European countries, USA and Japan, which are valid as of 2004. (This set could be actualized and extended by countries, which are traditionally seen as tax havens.) Also Feld et al. (2013) summarized data about double taxation for quite different sample of countries.
Hypothesis #1 (direction of flow) can be tested using binary choice model (logit or probit) developed in line with previous application of Huizinga and Voget (2009). This model is based on assumption that newly merged company will choose country, which provides more benefits, to be the residential (parental).
Testing of hypothesis #2 (volume) can be based on gravity models, which are very common in international trade research and it was used also by Di Giovanni (2005) or by Huizinga and Voget (2009) on field of cross-country M&A.
Finally, the question, how much the companies benefits from tax inversion (Hypothesis #3 – profitability), can be answered by the final takeover premium or by ex post performance of newly merged company. Both approaches have their limits. Unaffected takeover premium can be seen as total gross benefit of takeover under assumption that all the benefits from takeover are captured by target’s shareholders and acquirer does not benefit nor lose in the takeover at all. Even though this assumption seems very strong and even unrealistic, some theories (e.g. free-rider model of Grossman and Hart 1980) suggest this outcome and also some empirically studies conclude that while the acquirer ends up on average with zero (meaning that they pay for target as much as it worth to), the only beneficiary is the target. The alternative approach of modelling profitability of takeover can be conducted using post-takeover performance. The drawbacks of this approach are a) what is the appropriate measure of performance (commonly used are post-takeover market value or net income in following period), and mainly b) how the counterfactual is modelled (in other words, it is necessary to predict, what would have happened if the takeover had not occurred. In case of evaluation of post-takeover market value the common approach is modelling the counterfactual using abnormal return analysis based on CAPM model. The counterfactual for net income often is the last net income adjusted by average growth rate. Detailed overview of corporate takeover literature and especially of determinants of takeover premium and evaluation of post-takeover premium is provided by Betton et al. (2008).
Therefore, I would expect that higher potential tax savings lead also to higher takeover premium and better post-takeover performance. Rossi and Volpin (2004) built and estimated a model explaining the takeover premium in cross-country takeovers, but they did not control for tax differences between the countries. Nevertheless, according to the best of my knowledge, there is no study evaluating the post-takeover performance of cross-border M&As.
Finally, there is large space for potential extensions that can be part of this thesis and built up on same models. For example, the issue of base erosion and profit shifting can be considered because connecting the stand-alone company to the multinational firm can lead to potential tax benefits from profit shifting (see Dharmapala 2014 for overview). Next, the issue of “Tax treaty shopping” (Weyzig 2012) can be considered, because the reduction in double taxation is not only issue of tax treaties and avoidance of withholding taxes can be next motivation for cross-border M&As. Moreover, the recently developed Financial Secrecy Index (Cobham et al. 2015) calls for application in various financial cross-country researches and it could be hypothesize that higher scored countries (providing more secrecy) attract and provide consequent benefits to overtaken companies from lower scored countries.

Expected Contribution:
This way of studying market for corporate control is not so common, hence just the verification of previous findings (Huizinga and Voget 2009, De Giovanni 2005) is meaningful contribution to the existing research. Moreover, according to my knowledge there is only limited research of how the tax inversion affects post-takeover performance (Desai and Hines 2002). My thesis will contribute to this topic substantially and provides uniquely complete picture of direction, volume and profitability of cross-border M&As in context of taxation. Also I believe that better understanding of how much the companies benefit from tax inversions in terms of market value can help to set reasonable regulation in international tax competition. Finally, there is a debate about how the tax havens can be recognized and the cross-border M&A data can definitely help to resolve this debate and indicate countries that are abnormally attractive for tax inversion deals.
References
Americans for Tax Fairness, 2015, Pfizer´s Tax Dodging Rx: Stash Profits Offshore
Altshuler, Rosanne, Harry Grubert, and T. Scott Newlon. c2001. “Has Us Investment Abroad Become More Sensitive To Tax Rates?”. In International Taxation And Multinational Activity, T. Scott Newlon, 9-38. Chicago, Ill.: University of Chicago Press.
Betton, Sandra, B. Espen Eckbo, and Karin S. Thorburn. 2011. “Corporate Takeovers”. In Handbook Of Corporate Finance: Empirical Corporate Finance, B. Espen Eckbo, 2nd ed., 2008:291-427. Handbooks In Finance. Boston: Elsevier/North-Holland.
Cobham, Alex, Petr Janský, and Markus Meinzer. 2015. “The Financial Secrecy Index: Shedding New Light On The Geography Of Secrecy”. Online. Economic Geography 91 (3): 281-303.
Desai, Mihir A., and James R. Hines. 409-440AD. “Expectations And Expatriations: Tracing The Causes And Consequences Of Corporate Inversions”. National Tax Journal 55.
Dharmapala, Dhammika. 2014. “What Do We Know About Base Erosion And Profit Shifting? A Review Of The Empirical Literature”. Online. Fiscal Studies 35 (4): 421-448.
Di Giovanni, Julian. 2005. “What Drives Capital Flows? The Case Of Cross-Border M&a Activity And Financial Deepening”. Online. Journal Of International Economics 65 (1): 127-149.
Feld, Lars P., Martin Ruf, Uwe Scheuering, Ulrich Schreiber, and Johannes Voget. 2013. “Effects Of Territorial And Worldwide Corporation Tax Systems On Outbound M&as”. Online. Ssrn Electronic Journal 13 (088)
Grossman, Sanford J., and Oliver D. Hart. 1980. “Takeover Bids, The Free-Rider Problem, And The Theory Of The Corporation”. The Bell Journal Of Economics 11 (1): 42-64.
Hines, J. R., and E. M. Rice. 1994. “Fiscal Paradise: Foreign Tax Havens And American Business”. Online. The Quarterly Journal Of Economics 109 (1): 149-182. doi:10.2307/2118431.
Huizinga, Harry P., and Johannes Voget. 2009. “International Taxation And The Direction And Volume Of Cross-Border M&as”. Online. The Journal Of Finance 64 (3): 1217-1249.
Rossi, Stefano, and Paolo F. Volpin. 2004. “Cross-Country Determinants Of Mergers And Acquisitions”. Online. Journal Of Financial Economics 74 (2): 277-304.
Scholes, Myron S., and Mark A. Wolfson. 1990. “The Effects Of Changes In Tax Laws On Corporate Reorganization Activity”. The Journal Of Bussines 63 (1). doi:Scholes, Myron S., and Mark A. Wolfson. . No. w3095. National Bureau of Economic Research, 1989.
Weyzig, Francis. 2013. “Tax Treaty Shopping: Structural Determinants Of Foreign Direct Investment Routed Through The Netherlands”. Online. International Tax And Public Finance 20 (6): 910-937.
Preliminary scope of work
1. Introduction and motivation: I will motivate research question by brief explanation of concrete case, explain what is the advantage of M&A data over the aggregate view of FDI and define some terminology used in M&A field, because the thesis should overlap to different fields.
2. Literature review and development of hypotheses: I will mainly summarize the literature needed for development of hypotheses and summarize the previous results.
3. Data: I will describe the data from SDC database, explain the data the calculation of double tax rates (Huizinga and Voget 2009), define other variables and provide summary statistics.
4. Empirical analysis: The methodology and results for each hypothesis will be presented separately one by one, because each of them requires quite different model.
5. Extension: Financial Secrecy Index: The models can be re-estimated using Financial Secrecy Index (alternatively, this part is included in chapter 4.)
6. Discussion and conclusion: I will summarize the results, compare them with previous research, show their potential usage in practise and suggest topics for further research according to limitations in my own analysis.
Preliminary scope of work in English
1. Introduction and motivation: I will motivate research question by brief explanation of concrete case, explain what is the advantage of M&A data over the aggregate view of FDI and define some terminology used in M&A field, because the thesis should overlap to different fields.
2. Literature review and development of hypotheses: I will mainly summarize the literature needed for development of hypotheses and summarize the previous results.
3. Data: I will describe the data from SDC database, explain the data the calculation of double tax rates (Huizinga and Voget 2009), define other variables and provide summary statistics.
4. Empirical analysis: The methodology and results for each hypothesis will be presented separately one by one, because each of them requires quite different model.
5. Extension: Financial Secrecy Index: The models can be re-estimated using Financial Secrecy Index (alternatively, this part is included in chapter 4.)
6. Discussion and conclusion: I will summarize the results, compare them with previous research, show their potential usage in practise and suggest topics for further research according to limitations in my own analysis.
 
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