Dividend Policy Inside the Multinational Firm

Article excerpt

This paper examines the determinants of profit repatriation policies for US multinational firms. Dividend repatriations are surprisingly persistent and resemble dividend payments to external shareholders. Tax considerations influence dividend repatriations, but not decisively, as differentially-taxed entities feature similar policies and some firms incur avoidable tax penalties. Parent companies requiring cash to fund domestic investments, or to pay dividends to common shareholders, draw on the resources of their foreign affiliates through repatriations. Incompletely controlled affiliates are more likely than others to make regular dividend payments and to trigger avoidable tax costs through repatriations. The results indicate that traditional corporate finance concerns--taxation, costly external finance, and agency problems--are also critical to the internal capital markets of multinational firms.

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The choice of whether to repatriate earnings from a foreign subsidiary is one of the most important decisions in multinational financial management. This paper identifies the factors that shape repatriation policy, thereby illuminating the functioning of the internal capital markets of multinational firms.

Dividend repatriations represent sizable financial flows. In 1999, a year in which US corporations listed in Compustat had after-tax earnings of $516 billion and paid $198 billion in dividends to common shareholders (Grullon and Michaely, 2002), the foreign affiliates of US multinational firms had after-tax earnings of $182 billion and repatriated $97 billion to the United States as dividends. Dividend repatriations are so large that part of the motivation for the partial repatriation tax holiday in 2005 was that the resulting inflow of funds from abroad might be large enough to have positive macroeconomic consequences for the US economy.

Surprisingly, relatively little is understood about the characteristics and determinants of the policies governing these payments. This paper analyzes the repatriation behavior of virtually all US multinational parent firms and their subsidiaries from 1982 to 2002. The paper identifies three factors that shape dividend policy within the multinational firm: 1) the taxation of dividend income, 2) domestic financing and investment needs, and 3) agency problems inside firms.

The flows of capital analyzed in this paper consist of payments to multinational parent firms declared out of the income of foreign subsidiaries. These flows do not include the repatriation of invested equity. As described below, tax considerations alone would suggest that dividend policies inside the firm would be irregular and lumpy. But in contrast to these predictions, dividend repatriations are quite regular and can be characterized by a process of partial adjustment that was first described by Lintner (1956). Multinational firms behave as though they select target payouts for their foreign affiliates, gradually adjusting payouts over time in response to changes in earnings. Current dividends by affiliates rise by roughly $0.40 with every additional dollar of their after-tax profits. This pattern of persistent payouts does not appear to be an artifact of other regular investment or financing decisions at the affiliate level.

Comparing the behavior of foreign affiliates whose dividend repatriations are subject to high rates of tax with the behavior of affiliates whose dividends are not subject to tax illuminates the relevance of tax factors. Desai, Foley, and Hines (2001) show that firms pursue dividend payout policies designed in part to reduce tax obligations. However, further analysis shows that tax minimization cannot explain a significant portion of the dividend policies observed inside firms. Sharply distinctive tax treatments across organizational forms are associated with only modest differences in dividend policies. Some firms even appear to engage in a variety of tax-penalized behavior that involves the simultaneous repatriation of a dividend and investment of new equity in the same subsidiary. …