Internal Ownership Structures of Multinational Firms Abstract

Internal Ownership Structures of Multinational Firms

Katharina Lewellen Tuck School at Dartmouth [email protected] Leslie Robinson Tuck School at Dartmouth [email protected]

January 2013

Abstract This paper analyzes foreign ownership structures of U.S. multinational firms. Though the vast majority of foreign subsidiaries are ultimately wholly-owned by their U.S. parents, the way these subsidiaries are arranged within ownership structures varies strongly across firms. We document the key properties of these internal ownership structures and explore their potential determinants, including taxes, political and expropriation risks, and financing costs. More broadly, we show that firms choose their ownership structures in response to legal and tax rules imposed by their host countries, with potentially significant implications for how these rules affect economic activity.

________________________________________________________________________ We thank Andrew Bernard, Ken French, Ray Mataloni, Rafael La Porta, Richard Sansing, Bill Zeile and the participants of the 2013 UNC Tax Symposium for helpful comments. The statistical analysis of firmlevel data on U.S. multinational companies was conducted at the Bureau of Economic Analysis (BEA), Department of Commerce under arrangements that maintain legal confidentiality requirements. The views expressed in this study are those of the authors and do not reflect official positions of the U.S. Department of Commerce.

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Introduction At the end of 2011, the U.S. direct investment position abroad was $4.2 trillion

(Barefoot and Ibarra-Catton, 2012). One way a firm might structure its foreign investments would be to set up a directly-owned subsidiary in each country in which it operates. Though some multinationals adopt such flat ownership structures, other firms are substantially more complex. Foreign subsidiaries sometimes form long ownership chains, so that the U.S. parent owns many affiliates indirectly, and the chains can be linked to each other creating intricate structures such as that of Hewlett Packard in Fig. 1 (reproduced from U.S. Senate (2012)).

HPCO

Fig. 1: Ownership structure of the Hewlett Packard Co for fiscal year 2010. The figure is reproduced from U.S. Senate (2012). Each box denotes an affiliate of HP, and each line denotes an equity ownership link. Most affiliates are located outside of the U.S., including Germany, Spain, Netherlands, Luxemburg, Denmark, Israel, China, Japan, Taiwan, and Bermuda.

This paper analyzes the determinants of internal ownership structures for a sample of large U.S. multinationals. Our goal is to begin understand the potential forces that drive these structures – both their nature and relative importance. We coin the term internal structures to emphasize the fact that the vast majority of foreign subsidiaries are ultimately wholly-owned by their U.S. parent. Thus, these structures are not pyramids in the sense of LaPorta, Lopezde-Silanes, and Shleifer (1999), and the forces that shape them are likely different that those examined in their paper (or related literature).

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Multinationals account for a large fraction of the global economy and understanding how they are organized is important for researchers and policy makers. Economists have traditionally studied firms’ real activities, such as employment, investment, and trade. These activities are conducted within a set of legal rules, and firms can adapt to these rules, in part, by changing the way they are organized. These internal choices are important for two reasons. First, the ability to create structures like those in Fig. 1 can affect firms’ real decisions, such as, where to locate assets, employment, or production. Without accounting for this flexibility, the real choices cannot be fully understood. Second, if firms design the internal structures to circumvent the tax and legal constraints imposed by their host countries, then recognizing these choices is important to evaluate what policies can be effective. As an example, the literature on Foreign Direct Investments (FDI) examines, among other things, what drives FDI and how foreign investments affect welfare and growth.1 However, significant foreign investment flows are indirect in the sense that capital is channeled – for tax or legal reasons – through intermediate owner entities located in third countries.2 Consider, for example, that Cyprus – one of the smallest countries in Europe – ranks among the top capital exporter and importer countries for Russia, while Mauritius plays a similar role for India, and Netherlands for Brazil. Thus, the analysis in this paper improves our understanding of how firms conduct FDI and how specific policies affect cross-border investment flows. We begin by developing a general framework for thinking about internal ownership decisions and arrive at five potential forces that might affect these choices, including historical accidents (our frictionless benchmark scenario), tax and financing considerations, and the desire to limit political and expropriation risks. To evaluate how important these forces are in practice, we develop predictions for how each of them should affect the observed structures and then test these predictions on a sample of large U.S. firms.

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This research can be traced back many decades (see, for example, Mundell (1957)). Bhagwati et al. (1987) and others examine the effects of trade policy on FDI, while Wilson (1999), Davies and Ellis (2007), Blonigen and Davies (2004) and others focus on tax policy and tax competition. 2 If a significant number of multinationals are organized this way, then direct investment positions will imperfectly reflect where real activities actually occur (Lipsey, 2007). Recognizing these challenges, the European Commission required in 2007 that EU countries supplement the traditional FDI statistics with data on foreign investments by the country of the ultimate (rather than the direct) owner of the assets (see Foreign Affiliates Statistics (FATS) Regulation (EC) No 716/2007).

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Our empirical approach is to focus on two key features of ownership structures: the characteristics of owners (i.e., foreign affiliates that own other foreign affiliates), and the characteristics of owner-daughter pairs (i.e., pairs in which two foreign affiliates form a direct ownership link). As we argue below, the focus on owners is a useful step towards understanding the structures more broadly. This is because an owner’s location, activities, and connections to other affiliates provide insight into the firm’s purpose for forming the structure. The first set of tests are logit regressions in which the unit of observation is an individual subsidiary. The model analyzes a firm’s choice to place a given subsidiary in the position of an owner within its structure. The second set of tests are tobit regressions where the unit of observation is a country pair. These regressions analyze a firm’s decision to form a direct ownership link across two countries. Our sample consists of 634 major U.S. multinational firms in years 1994, 1999, 2004, and the data come from the Bureau of Economic Analysis (BEA). Close to 40% of firms in our sample are flat in the sense that they have no cross-border ownership chains. The remaining firms comprise of a total of 33,051 foreign subsidiaries arranged into more complex ownership structures. Out of this total, 37% subsidiaries (corresponding to 57% of operating assets) are part of cross-border ownership chains, with 10% placed on the top or middle of chains (owner subsidiaries) and 27% placed on the bottom of chains. Close to 40% of the owner subsidiaries are holding companies, implying that the majority of their income comes from holding equity in other affiliates, while the remaining owners are primarily operating entities. Turning to our main tests, we find that tax considerations are an important factor in structuring foreign ownership, but that tax motives are only one of several distinct forces that drive internal structures. The structures can help firms minimize U.S. repatriation taxes, foreign withholding taxes, or foreign income taxes, and we find evidence that they are designed with all these tax considerations in mind. For instance, a direct ownership link is more likely to occur when withholding tax rates on dividends flowing from the daughter country to the owner country are low (Mintz and Weichenrieder (2010) document this pattern in a sample of German firms). Owners also exhibit both lower statutory and effective income tax rates, consistent with internal ownership decisions reflecting firms’ desire to minimize U.S. repatriation taxes (Altshuler and Grubert, 2002). Finally, a direct ownership link is more likely to occur when both the owner and daughter countries are tax haven jurisdictions,

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consistent with firms using ownership chains involving tax havens to minimize foreign income taxes (Desai, Foley, and Hines, 2006). We also find that owners are significantly more likely to conduct R&D than entities placed in other positions within firms’ ownership structures. This finding is also consistent with tax motives and suggests potentially important interactions between tax policies that facilitate foreign investment flows and the location of certain real activities, such as R&D. For instance, Belgium, Ireland, Luxembourg and Netherlands each offer tax benefits to firms with significant intangible assets and also offer generous tax climate to foreign owner entities (see Eicke, 2009, Dorfmueller, 2003, and Macovei and Rasch, 2011).3 Overall, our findings illustrate the complexity of the international tax rules, and the many ways in which multinational firms can save taxes using efficient ownership structures. The tests also show that many (though seemingly not all) large U.S. firms take advantage of these opportunities. This highlights more fundamental questions about the effectiveness of taxation in a multinational setting, discussed, for example, in Gordon and Hines (2002) and Devereux (2007). In addition to tax motives, we find that concerns about political and expropriation risks help explain ownership structures. A firm can limit those risks by taking advantage of international agreements designed to protect foreign investors against various forms of expropriation. We find that these bilateral investment treaties (BITs) are relevant in how firms structure their foreign operations. For example, two subsidiaries are more likely to form an ownership link with each other if their host countries have a BIT in place. Similarly, countries with extensive BIT networks are preferred locations for owners. Three additional pervasive patterns emerge from our tests. First, owners tend to locate in countries with stronger property rights. This finding points to the importance of a country’s institutions – beyond tax policies – in attracting indirect capital flows. Second, two subsidiaries within a given structure located in countries with stronger economic and cultural

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These interactions are important, especially given the rise in the adoption of holding company regimes – e.g., Chile in 2002, Sweden in 2003, Ireland in 2004, Hungary in 2006, Malta in 2007, and South Africa and Latvia in 2012. (The U.S. does not have laws providing for favorable treatment of holding companies.) The tax benefits these regimes provide to multinational groups include reduced taxes on dividends, reduced taxes on capital gains from the disposal of holdings, or interest deductibility on loans to acquire holdings (see www.deloitte.com/holdingcompanies).

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ties (e.g., common language, religion, or colonial history) are substantially more likely to form an ownership link. This suggests that business and financing ties overlap within multinational groups, consistent with firms choosing the financing ties to minimize internal financing costs. Finally, the presence of an outside owner within a group has a significant impact on its ownership structure. First, subsidiaries with outside owners tend to be indirectly owned by their U.S. parent, and second, they are unlikely themselves to be owners. Both findings are consistent with the structures limiting financial exposure to foreign partners. Our paper follows a long tradition of economic research focused on interactions between governments and firms. For example, in finance, researchers have long been interested in the effects of tax policy on capital structure (see review in Graham (2003)), and more recently, on governance (e.g., Desai, Dyck, and Zingales (2007)), and a large literature in economics studies the impact of tax policies on investment and economic growth (see reviews in Auerbach (2002), Hassett and Hubbard (2002), Gordon and Lee (2005), and Feldstein (2006)). A number of prior studies examine financing and investment choices of U.S. multinationals. Researchers have analyzed, for example, the multinational firms’ use of debt, their dividend policies, decisions to form joint ventures with foreign firms, and the importance of financing frictions for investment, (Desai, Foley, and Hines (2004a, 2004b, and 2006) and Desai, Foley, and Forbes (2008)). In addition, Desai, Foley, and Hines (2006) examine firms’ tax avoidance strategies involving tax havens, Altshuler and Grubert (2002) show how tiered ownership can reduce U.S. taxation on foreign dividend repatriations, and Desai, Foley, and Hines (2003) show that investment of foreign subsidiaries is more sensitive to foreign tax changes when the subsidiaries are indirectly owned by the U.S. parent. This latter result suggests, consistent with our findings, that internal ownership arrangements can help shield foreign affiliates from U.S. taxation. The remainder of this paper is organized as follows. Section 2 develops our theoretical framework. Section 3 describes the data and sample construction. The empirical tests and results are discussed in Section 4, and Section 5 concludes.

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2

Determinants of internal ownership structures This section develops a framework for analyzing internal ownership structures. As we

explain earlier, our focus is on two features of the structures: the attributes of owner subsidiaries and their host countries and the attributes of country pairs with direct ownership links. We lay out five forces that could drive internal ownership decisions (the list is likely not complete) and derive predictions for how each force should affect these two features of the observed structures.

US Co.

A

B

F

G

D

C

E

H Fig. 2: Example of a hypothetical ownership structure. In the figure each subsidiary is located in a different country and is ultimately wholly-owned by the U.S. parent.

The two sets of predictions are illustrated in Fig. 2. The first set of predictions concerns the attributes of owner subsidiaries, such as entities A, B, and G, as compared to a benchmark sample of non-chain subsidiaries C, D, and E. (In some settings, the benchmark can also include bottom subsidiaries, such as F and H.) The second set of predictions concerns the attributes of country pairs that are connected to each other through direct ownership links (such as pairs A-F, B-G, and G-H) as compared to other country pairs that could have formed a direct ownership link but do not (e.g., pairs F-A, C-D, or G-B). Note that the position of the subsidiary in the owner-daughter link is important to the design of our empirical test (e.g., AF forms an ownership link while F-A does not). The hypotheses are described below and are summarized in Fig. 3. 2.1

Baseline hypothesis: historical accident Our benchmark hypothesis assumes that firms set up a separate subsidiary in each

country they operate but that, otherwise, they face no transaction costs, taxes, or other frictions. In this world, the choice of ownership structures is irrelevant for the firm (as in

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Modigliani-Miller), and consequently, the structures may evolve randomly over time. At the time of the initial expansion abroad, the U.S. parent sets up a number of directly owned subsidiaries. As the firm evolves, additional subsidiaries are added to (or eliminated from) the structure. The ownership links of new affiliates are random: any affiliate can be owned either directly by the parent or by any other affiliate in the group with equal probability. The pure historical-accident scenario can be rejected as long as ownership structures are not completely random but follow some systematic patterns. It is possible, however, that historical factors explain some regularities within the structures. For example, if these factors are important, we would expect that older subsidiaries are more likely to be owners, and that they are located higher up in ownership chains. 2.2

Transaction costs As a next step, suppose that transferring funds across subsidiaries is costly, though less

so than obtaining cash from outside the group. So when a new affiliate is formed (or when an existing affiliate needs additional funds), the subsidiaries that have excess cash at that time will be more likely to provide capital. This implies that, other things equal, historically more profitable entities have higher odds of becoming owners. (This pattern would be reinforced if the firm tries to defer repatriation of profits to the U.S. for tax reasons, which we discuss separately below.) Next, suppose that the costs of transferring funds across subsidiaries are not uniform across a multinational group. In particular, the costs are lower for entities that transact with each other for commercial (rather than financing) reasons, for example, through customersupplier relationships, through conducting operations in the same product market or geographic area, or through collaboration on projects. If so, we expect that such economically connected entities will be more likely to have ownership links. Finally, suppose that firms actively minimize transaction costs by centralizing their financing functions within separate units. These entities, which we call financing hubs, would then specialize in performing financial services for the group, including raising capital from outside parties, intra-company lending, or cash management. They would arise as long as centralizing these activities creates economies of scope or scale. Because hubs specialize in financing of other affiliates, they are naturally more likely to become owners, and might thus be responsible for the ownership structures we observe. Moreover, if some owners focus on

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financing activities, we expect them to locate in better developed countries, i.e., countries with stronger property rights and better-functioning financial markets. 2.3

Taxes This section outlines implications of foreign and U.S. tax rules for the firms’ choice of

owner subsidiaries and owner-daughter pairs within multinational groups. The discussion is far from complete: the number of strategies used in practice is larger and is changing over time. Background on taxation of multinational firms is in Appendix A. 2.3.1

Cross-country differences in taxation of foreign income Differences in countries’ approach to taxation of foreign income and cross-border flows

can make a country a more or less attractive location for owner subsidiaries. Two features are especially important. First, firms should be more likely to locate owners in countries that have either a territorial tax system or a worldwide tax system with a broad exemption for foreign dividends. In both of these cases, the dividends paid from the daughter subsidiary to the owner are not likely to be subject to a residual tax in the country of the owner. Second, a country’s approach to curbing tax avoidance by multinationals could play an incremental role. If firms consider anti-abuse rules as constraining, then they may locate their owner subsidiaries disproportionately in countries in which these rules are weak or non-existent. An example is controlled foreign corporation legislation (called subpart F) in the U.S. which subjects certain passive income received by a foreign subsidiary – such as dividends, interest, and royalties – to a U.S. residual tax on an accrual basis (i.e., immediately rather than upon repatriation; see Appendix A). 2.3.2

Taxes other than income taxes By choosing its ownership links in a tax efficient manner, a firm can limit withholding

taxes on cross-border dividend payments, or even eliminate them altogether. Other things equal, the preferred ownership link would involve a subsidiary located in a country with low (or zero) withholding tax rate on dividends flowing to the country of its direct owner. More broadly, firms should favor countries with low withholding tax rates on inbound dividends as

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host countries for their owner subsidiaries.4 In addition to dividends, capital contributions made by one affiliate to another can be subject to a capital duty, and some countries impose a stamp duty on transfer of shares or bonds. Other things equal, firms should place their owners in countries with no capital or stamp duties in place. Fig. 3: Summary of hypotheses Hypotheses:

Attributes of country pairs with ownership links. Fig. 2: pairs A-F, B-G, and G-H vs. other possible pairs

Historical accident

Attributes of owners vs. benchmark nonowners. Fig. 2: A, B, G vs. C, D, E  Owners are older, more mature

--

Transaction / financing costs

 Ownership links are more likely between  Owners are more profitable subsidiaries located in countries with  Owners have stronger economic ties to stronger economic ties, proxied by: other affiliates  Geographic distance  Are part of larger regional and industry  Cultural ties: same language, religion, groups within firms colonial link  Have larger trade flows with other  Bilateral trade flows, trade agreements subs within the group  Owners specialize in financing activities  Owners, especially holding owners, locate in countries with better institutions

Taxes

 Ownership links are more likely between  Owners are more profitable subsidiaries located in countries  Have lower effective (statutory) tax rates  With lower withholding tax rates on  Locate in countries: dividends paid from the daughter to  with lower withholding tax rates on the owner country inbound dividends  With a tax treaty in place  with a territorial tax system, no  Characterized as tax havens corporate tax system, no capital or stamp duties, no anti-abuse legislation, better overall tax treaty network, and in tax havens

Expropriation risks

 Connected subsidiaries are more likely  Owners locate in countries with more extensive investment treaty network located in countries with a BIT in place

Outside owners

--

 Owners have lower likelihood of outside ownership

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Unlike withholding taxes on dividends, those levied on royalties and interest payments generally apply independently of whether the transacting affiliates have a direct ownership connection. However, strategies aimed at reducing withholding taxes on royalties and interest have indirect implications for ownership structures if hybrid structures are used to achieve U.S. tax deferral on intercompany interest or royalty payments (see Section 2.3.3).

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2.3.3

The U.S. tax system and tax deferral When the home country of the multinational firm is the U.S., additional tax

considerations can have a bearing on internal ownership structures. In particular, the U.S. tax system subjects foreign dividends to a residual U.S. tax on a deferral basis (i.e., upon repatriation to the U.S.) and allows a tax credit for foreign taxes paid on the repatriated income (see details in Appendix A). A direct implication of tax deferral is that foreign subsidiaries with excess cash should avoid repatriation of foreign profits and should instead use the profits to finance investment opportunities abroad. As a result, historically more profitable subsidiaries should be more likely to make equity contributions to new or existing subsidiaries, and thus, should have a higher chance to become owners (Altshuler and Grubert (2002), Desai, Foley and Hines (2003) Edwards, Kravet, and Wilson (2012), Hanlon, Lester, and Verdi (2012)). This prediction follows also from the transaction costs hypothesis described in Section 2.2. However, if the deferral considerations play an incremental role, then subsidiaries located in low-tax jurisdictions – i.e., those that benefit most from deferral – should be especially likely to become owners. Some specific repatriation strategies may require that the owner entity is located in a country with a higher tax rate than its daughter entity (we denote such ownership link as ‘HL’), while other strategies require the opposite (‘L-H’) configuration. Examples of such strategies are described in Appendix B and in Altshuler and Grubert (2002)). Because of this ambiguity, these strategies have no clear-cut prediction about which of the two ownership link types should be more frequent in the data. However, additional incentives to use the ‘L-H’ type ownership link may arise from strategies aimed at shifting income from high-tax to low-tax jurisdictions. This is because some income shifting strategies involve the so-called hybrid structures set up to defer U.S. taxes on passive income, such as interest payments or royalties. The structures – if used for the purpose of income shifting – typically involve owners in low-tax countries owning affiliates in high-tax countries, and thus, suggest more frequent ‘L-H’ links (see the

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discussion of Subpart F of the U.S. tax code in Appendix A; see also Altshuler and Grubert (2005), Grubert (2012), U.S. Senate (2012)).5 Overall, our approach is to examine both types of connections (‘H-L’ and ‘L-H’) empirically, and to test whether specific strategies appear to dominate in practice. We also test whether the absolute value of the difference between two countries’ tax rates predict the likelihood of an ownership link. 2.4

Expropriation risks The next factor we examine concerns multinational firms’ reliance on investment

protection treaties as a way to limit political and expropriation risks in their host countries. Many less developed countries have entered into such agreements with developed countries in recent years. For example, there were 470 treaties in place in 1990 compared to 2,181 in 2002 (see Neumayer and Spess (2005) and Hallward-Dreimeier (2003)). These Bilateral Investment Treaties (BITs) guarantee certain standards of treatment and provide protection against various forms of expropriation to foreign investors residing in the signatory countries.6 If firms view these protections as valuable, they should take them into account when designing their ownership structures. Concretely, we expect that, other things equal, a firm investing in a foreign country should channel its investment through an entity located in a country that has an appropriate BIT. Similarly, we expect that subsidiaries located in countries with extensive BIT treaty networks should be used more frequently as owners of other entities within a group. 2.5

Limited liability and outside owners Concerns about limited liability are central when firms decide which of their assets or

activities should be separated vs. combined within legal entities. A setting in which limited liability has a direct implication for ownership structures involves international joint ventures. A U.S. firm can form an international joint venture by establishing a separate legal

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Mutti and Grubert (2007) also discuss these hybrid structures, noting that BEA data retain the identity of individual establishments even if they are part of a hybrid structure. 6 Many treaties define expropriation broadly as including not only a government taking possession of a firm’s assets, but also other government actions that negatively affect firm value, such as adverse changes in laws or tax rules. Most treaties establish clear procedures for dispute resolution. They usually allow foreign investors to bypass national legal systems and bring their cases to an international court, usually the International Centre for Settlement of Investment Disputes (ICSID), an affiliate agency of the World Bank.

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entity abroad with a foreign partner.7 The resulting joint venture company is usually a corporation in which the firm and its partner hold equity stakes. A simple way in which the firm can limit its financial exposure towards the foreign partner is to enter into the joint venture agreement indirectly through one of its subsidiaries rather than directly through the parent. In addition, if the outside owner’s claims are to be limited to assets of the joint venture, then the jointly owned entity (and possibly also its direct owner) should not hold equity in unrelated affiliates. This implies that joint ventures should be more likely indirectly owned and should be less likely to hold equity in other affiliates.

3 3.1

Data and descriptive statistics Data and sample Data on U.S. multinational firms come from the Bureau of Economic Analysis (BEA)

Benchmark Survey of U.S. Direct Investment Abroad, a legally mandated survey that is conducted for the purpose of producing publicly available aggregate statistics on U.S. multinational company operations. This survey includes financial data on both the domestic and foreign operations of U.S. multinationals. In accordance with the internationally accepted definition of foreign direct investment used for the compilation of balance-of-payments statistics, a U.S. firm is included in the BEA survey if it has at least a ten percent equity ownership interest (direct or indirect) in at least one foreign affiliate. The survey forms required by the BEA vary depending on the year and the type of respondent. The benchmark survey forms we use include detailed ownership information and cover three years: 1994, 1999, and 2004. In these benchmark years, parents are required to complete extensive surveys for all affiliates with sales, assets, or net income (absolute value) in excess of a relatively low ‘reporting threshold’.8 As our focus is on foreign ownership structures, we limit our sample to firms with significant foreign operations. Specifically, we require that each firm has at least ten foreign affiliates and that the sales of all of the firm’s foreign affiliates account for at least 20% of the

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Desai, Foley, and Hines (2004a) analyze international joint ventures of U.S. multinational firms. Legal aspects of international joint ventures are described, for example, in Wolf (2000). 8 The reporting threshold for affiliates was $3 million, $7 million, and $10 million in 1994, 1999, and 2004, respectively. To contrast, in the intervening non-benchmark years 1995 through 1998 and 2000 through 2003, the reporting threshold was $20 million and $30 million, respectively. The revised benchmark survey data for 2009 is not yet available to academic researchers.

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firm’s worldwide sales. If a firm satisfies this condition in at least one of the three benchmark years, it is included in our sample in all available years. These requirements result in an initial sample of 1,278 firm-years (643 firms). Within the initial sample, 486 firm-years involve flat ownership structures, that is, structures with no cross-border ownership connections other than to the U.S. parent. For the remaining 792 firm-years (453 firms), ownership structures are more complex (i.e., involve some cross-border ownership links between foreign subsidiaries), and this is the sample we use in our main tests.9 We use country data on countries’ Gross Domestic Product (GDP) and GDP per capita from the World Bank, and the property rights index from Andrei Shleifer’s website (see also LaPorta et al. (1998)). Data on investment treaties and trade flows comes from the United Nations Conference on Trade and Development (UNCTAD) and the World Bank, data on trade agreements comes from the NSF-Kellogg Institute database (see also Baier and Bergstrand (2007)). We obtain tax information from Comtax, Worldscope, Deloitte & Touche Country Tax Guides, KPMG Taxation and Investment Guides, and Ernst & Young Worldwide Corporate Tax Guides. 3.2

Descriptive statistics Table 1 shows descriptive statistics for our multinational firms, computed separately for

those that have flat versus complex ownership structures. The average complex firm is larger and more diversified than a flat firm. It has worldwide assets of $23.2 billion (the median is $3.7 billion) and 55 subsidiaries spanning 24 countries and 7 industries. This compares to $4.3 billion in assets (the median is $0.8 billion) and 19 subsidiaries spanning 15 countries and approximately 2 industries for flat firms. For an average complex firm, owners constitute 15% of all foreign subsidiaries, and 37% of all owners are classified as holding companies by the BEA. This classification implies that their income comes primarily from holding of equity in other affiliates.10 The mean (maximum) number of affiliates held by an owner is, on

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Both the flat and the complex structures could involve some ownership connections between subsidiaries located in the same country. Our focus is on explaining the cross-border ownership links, so the intracountry links are not considered. Note also that the BEA allows firms to combine entities located in the same country (and that are either part of the same integral business or operate in the same 4-digit industry code) into larger reporting units, so that we are unable to observe all intra-country links. In contrast, entities located in different countries may not, under any circumstances, file a combined BEA report. 10 In our sample, the BEA’s international surveys industries (ISI) classifications are based on the 1997 North American Industry Classification System (NAICS) and the 1987 Standard Industrial Classification

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average, 2.5 (6.5) and is similar for holding owners at 2.8 (5.4). Notably, 19 percent of top tier subsidiaries in which the U.S. parent holds a direct equity interest re-cycle at least a portion of that inward investment outto another country. In untabulated data, we find that this fraction varies strongly across countries, and is the largest for Luxembourg (42%), Panama (38%), Cayman Islands/British Virgin Islands (37%), and Netherlands (32%). Table 2 (and the remainder of our paper) focuses on complex firms and describes characteristics of subsidiaries by their positions within the structures.11 Out of the total of 33,051 subsidiaries, 20,686 are not part of any cross-border ownership chains. The remaining subsidiaries are split between the top, middle, and bottom of chains (the numbers are 1,767, 1,688, and 8,910, respectively). Compared to no-chain subsidiaries, owners (i.e., subsidiaries located at either the top or middle of chains) are substantially larger (based on operating assets or sales) and older, have a higher ratio of R&D to sales and a smaller ratio of PP&E to operating assets. Owner subsidiaries also have a higher fraction of intercompany sales on total sales, suggesting stronger business ties to other affiliates. The incidence of outside partners is lowest for owners and highest for entities at the bottom of chains (7% vs. 34%). Focusing on the host country attributes, compared to no-chain entities, owner subsidiaries tend to locate in countries with stronger property rights, in OECD and EU countries, and in tax havens. The host countries of owners have, on average, more extensive investment and tax treaty networks, and lower withholding tax rates on inbound dividends. Their host countries are also less likely to tax foreign income on a worldwide basis and have capital or stamp duties on transfers of shares or bonds. This points to tax considerations as a key factor in the firms’ choice of owners. Based on Panel B, this pattern holds for both the holding company owners (see definition in footnote 10) and the operating owners, though the holding locations seem especially tax friendly based on some criteria, such as capital and stamp duties or worldwide tax systems.

(SIC). The NAICS-based ISI code for holding companies is 5512 (holding companies, except bank holding companies) and the SIC-based ISI code is 671 (holding companies). BEA defines a holding company as a business “engaged in holding the securities or financial assets of companies and enterprises for the purpose of owning a controlling interest in them or influencing their management decisions. Businesses in this industry do not manage the day-to-day operations of the firms whose securities they hold. (…) A business that engages in holding company activities but generates more than 50 percent of its total income from other activities is not a holding company.” (BEA (2007), p. 46). 11 In 408 cases, a subsidiary appears at the top of some chains and also in the middle of other chains. We treat these subsidiaries as being at the top of a chain.

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4

Empirical tests Our empirical tests take two forms. In the first subsection, we explore the factors that

drive ownership structures by examining characteristics of owner subsidiaries within multinational firms. In the next subsection, we focus on characteristics of pairs of host countries that are connected to each other through ownership links. 4.1

Owner regressions In Table 3, we compare owner subsidiaries to a benchmark sample of all non-chain

subsidiaries, such as C, D, E in Fig. 2.12 We report separate regressions including all owners (Panel A) and only operating owners, i.e., owners that are not identified as holding companies by the BEA industry classification (Panel B). The dependent variable in both panels equals one for owners and zero for non-chain subsidiaries. In Panel C, we compare holding and operating owners to each other, with the dependent variable set to one for holding owners. All regressions include firm fixed effects. We also estimate regressions with firm and country fixed effects (without country characteristics) and obtain similar coefficients on the remaining variables to those reported in Table 3. 4.1.1

Historical factors, profitability, and economic ties The regressions in Table 3 show that both the historical-accident and the transaction

costs hypotheses help explain ownership structures. First, owner subsidiaries are significantly older than the benchmark sample. For example, in Panel A, 14% of all sample subsidiaries are owners, and increasing subsidiary age by one standard deviation, with all other variables at the mean, increases the likelihood of being an owner by 2.0 percentage points (the tstatistic for the coefficient on age is 8.3). Owner subsidiaries are also larger based on operating assets (t-statistic of 14.0 and a marginal effect of 5.1%), suggesting more mature operations.13 Consistent with the transaction costs hypotheses, subsidiaries with stronger economic ties to other affiliates are more likely to form ownership links. For example in Panel B, the

12

As a robustness test, we expand the benchmark to include also subsidiaries at the bottom of chains (such as F and H in Fig. 2), with similar results. 13 The historical factors are more consistent with characteristics of operating owners than holding company owners. For example, based on Panel C, holding companies are significantly younger than operating owners, suggesting that they are added at later stages of their firms’ lives.

15

likelihood of being an operating owner increases with the proportion of the subsidiary’s interaffiliate sales on total sales, and it is also higher for subsidiaries located in geographic regions (or operating in industries) in which the firm has a larger number of affiliates. All three effects are significant at the 1% level, and the marginal effects are 0.4, 0.2, and 0.2 percentage points (untabulated), respectively (9% of all subsidiaries in Panel B are operating owners). Interestingly, however, there is no evidence that owners are more profitable than the benchmark sample. This prediction follows from an internal pecking order behavior whereby subsidiaries with excess cash flow provide capital to other parts of the firm. One explanation might be that our historical ROA measure is not a good proxy for excess cash. For example, the variable might also proxy for the subsidiary’s own opportunities to invest. 4.1.2

Financing hubs The evidence in Table 3 reveals several features of ownership structures that are

consistent with the use of financing hubs. For example, we find that 41% of all owner subsidiaries are classified as holding companies by the BEA, which means that most of their income comes from the operations of their daughter companies (see definition in footnote 10).14 Panel C of Table 3 shows that these entities are significantly younger than other owners, implying that they have been created at later stages of their firms’ lives. Based on some criteria, the holding-company owners tend to locate in countries with better tax environments than other owners. Specifically, they have lower withholding tax rates and a lower incidence of stamp or capital duties, which is consistent with their more significant role in tax planning (we discuss the tax findings in more detail in Section 4.1.3). However, the distinction between operating and non-operating owners is far from clearcut, and the two categories of owners share a number of important features (as compared to the benchmark non-owner subsidiaries). For example, both types locate in better tax environments than the non-chain benchmark (see coefficients on Statutory Tax rate, Tax

14

As a robustness test, we repeat all regressions using two alternative definitions of holding companies, with largely similar results. The first definition classifies an entity as a holding company if its total sales are zero; the second definitions classifies and entity as a holding company if its total assets are at least 50 percent in the form of equity investments in other affiliates.

16

Haven, Worldwide Taxation and Capital and/or Stamp).15 Also, in Section 2.2 we argue that financing hubs – because they, by definition, engage in financing activities – might benefit more strongly from high-quality institutions than other affiliates. In Table 3, we find that country governance, as measured by the property rights index and the OECD dummy, plays a role in the location choices of both types of owners, though the effect appears stronger for holding companies. If owner subsidiaries are financing hubs, then we should see evidence of internal and external financing activities within this group of affiliates. We do not have detailed data on financing transactions between foreign subsidiaries, so the evidence is indirect. What we can measure is the use of debt and cash in the affiliates’ balance sheets. We find that owners have lower leverage than the benchmark sample of non-chain entities, and that leverage is especially low for holding-company owners. This seems surprising given the anecdotal accounts that holding companies borrow to finance other affiliates in the group (see, for example, Jansen (2011)). Based on our results, owners, including holding companies, tend to finance themselves with equity rather than debt. Similarly, we find no evidence that holding companies hold more cash than their benchmark samples. Overall, these findings raise questions about the precise role holding companies play within multinational groups, and specifically, to what extent financing and cash management is part of that role. 4.1.3

Taxes We examine a number of tax-related motives for the location of owners and find strong

evidence that firms design their ownership structures to minimize taxes. First, owners are located in countries with lower statutory tax rates and have lower entity-specific effective tax rates compared to non-owners. This is consistent with tax motives playing a role in the location of owners. For example, basic tax deferral strategies imply that subsidiaries located in low-tax jurisdictions, and thus benefit more from deferral, should be more likely to postpone repatriation by investing in (or acquiring) foreign affiliates. Second, owners are significantly less likely to locate in countries that tax foreign dividend income. The dummy variable for countries with a worldwide tax system with no tax

15

The regression comparing holding companies to the non-chain benchmark is not reported. In this regression, all of the four tax variables are significant at the 1% level and the coefficients have the same signs as those in Panels A and B.

17

exemption for foreign dividends (such as the U.S. tax system) is negative and significant for both types of owners. The marginal effect based on regressions in Panel A involving all owners is -1.8 percentage points (14% of entities included in these regressions are owners). Third, firms avoid placing owners in countries that impose capital or stamp duties on capital transactions. These effects are both statistically and economically highly significant for both types of owners. The t-statistic in the all-owner regression is -6.2, and the marginal effect is -4.6 percentage points. We also find that firms are significantly more likely to place owners in tax havens. The marginal effect of the tax haven dummy is 1.3 percentage points based on the all-owners regression. Fourth, owners tend to locate in countries with low average withholding tax rates on inbound dividends. The coefficients on average withholding tax rates are negative in all regressions, and are significant in the regression including all owners (t-statistics of -3.7). The marginal effect based on the all-owner regression is -1.2 percentage points. Based on Panel C, withholding tax rates are significantly more important in explaining the location of holding owners than operating owners, consistent with the idea that financing hubs are more likely to engage in tax planning or be set up for tax purposes. The fifth noteworthy and possibly also tax related pattern is that operating owners are more likely to engage in R&D than the benchmark non-owners (they also have a lower proportion of PPE to operating assets).16 One explanation might be that owner friendly and R&D friendly tax policies tend to coexist within the same countries, or that owner friendly policies, indirectly, also attract R&D.17 A simple reason might be that R&D projects, if successful, generate steady streams of cash flows, and the ability to transfer this cash flow across border in a tax efficient manner is valuable to the firm. Another not mutually exclusive explanation is firms’ use of tax planning strategies in which owners license the firm’s

16

We do not include PPE and R&D in the holding owner regressions because holding owners are by definition owners with insignificant operations, so we expect that they would mechanically have low operating assets and, possibly, low R&D. 17 A prominent owner country in our sample that has tax friendly environment for both holding companies and for R&D is Ireland. As a robustness test, we re-run the regressions excluding entities located in Ireland and find similar results to those reported in the table.

18

technology to daughter companies treated as hybrid entities, but only for U.S. tax purposes (see Darby (2007), U.S. Senate (2012), and Grubert (2012)).18 Sixth, we find little evidence that the existence of anti-abuse regulation discourages the location of owners. The coefficients on the dummy variables for CFC legislation, general anti-avoidance rules and thin capitalization rules are insignificant in the operating owner regressions, and are positive and significant for the first variable in the owner regression (see definitions of these rules in Appendix A). Moreover, based on Panel C, holding companies are more likely to locate in countries with anti-abuse regulation compared to operating owners. One explanation might be that countries that create tax friendly environments are also more likely to put in place regulation that discourages abusive tax avoidance. Finally, controlling for other country characteristics, owners tend locate in countries with less extensive tax treaty networks. This is interesting as it points to the potentially conflicting effects of tax treaties on firms. On the one hand, tax treaties benefit firms by limiting double taxation (among other things). On the other hand, they often contain agreements that facilitate sharing of tax related information between governments, which may deter some firms. This interpretation is consistent with findings in Blonigen and Davies (2004) who examine the impact of tax treaties on FDI. They conclude that there is “little evidence that bilateral tax treaties increase FDI activity, contrary to OECD-stated goals for such treaties” (p. 601).19 4.1.4

Expropriation risks The tests in Table 3 suggest that expropriation risks considerations play an important

role in designing ownership structures. They show that subsidiaries located in countries with more extensive investment treaty networks (measured using the number of BITs in effect) are significantly more likely to be owners. For example, in Panel B (which includes only operating owners), the corresponding t-statistic is 3.9 and the marginal effect is 1.1

18

R&D expenditures, as reported by a foreign affiliate to the BEA, do not include payments that an affiliate might make to its U.S. parent under a cost sharing agreement. Under these agreements, the affiliate finances a contractual portion of the annual R&D expenditures incurred in the U.S. 19 However, it is also possible that our tax treaty measure is negatively correlated with a country’s overall tax-friendliness, for which we may not fully control for, and that it is this underlying attitude rather that the treaty network itself that drives the negative coefficient. We examine this further in Section 4.2.

19

percentage points (9% of subsidiaries in the sample are operating owners).20 The finding points to the flexibility with which multinationals can take advantage of attractive treaties without changing the location of their real activities (and by adapting their ownership structures instead). In general, this may be difficult because governments sometimes deny treaty benefits to foreign investors that have no “substantial business activities” in their home countries (UNCTAD, 2005, p. 21).21 However, a firm that already has operations in multiple countries can choose as a direct investor any of its existing operating affiliates, and thereby, qualify for treaty benefits. This highlights the challenges faced by governments trying to design the investment and tax treaties with specific policy objectives in mind. 4.1.5

Outside ownership In our sample, 86% of subsidiaries are wholly owned by the parent. Based on Table 2,

outside ownership is concentrated among subsidiaries on the bottom of ownership chains (in this sample, the mean outside-ownership dummy is 34%), and it is least common among owner subsidiaries (the mean dummy is 7% for subsidiaries on the top of ownership chains, compared to 15% for non-chain subsidiaries). Multivariate tests yield results consistent with these patterns. For example, in Panel A of Table 3, 14% of sample subsidiaries are owners, and the implied likelihood of being an owner decreases by 2.2 percentage points at the mean of independent variables. Similarly, in unreported regressions, we find that outside ownership significantly increases the likelihood that a bottom entity is indirectly owned (controlling for other subsidiary characteristics and firm fixed effects). These patterns are consistent with ownership structures being designed, in part, to limit firms’ legal exposure towards outside owners. However, given that most entities – even those on the bottom of chains – are

20

The empirical evidence on the impact of BITs on the actual investment flows is mixed. For example, Neumayer and Spess (2005) document a positive association between the number of BITs signed by a developing country and the size of FDI flows to that country. In contrast, Hallward-Driemeir (2003) and Tobin and Rose-Ackerman (2004) report either no effect or a negative effect of BITs on FDI flows. A recent study by Aisbett (2009) argues that the finding in Neymayer and Spess may be due to an endogeneity bias (BITs tend to be signed during periods of increasing FDI flows), and that after accounting for the bias, there is no evidence that BITs increase FDI. 21 The denial-of-benefits clauses included in some BIT agreements are meant to discourage firms from setting up ownership structures solely to obtain treaty benefits (the so-called treaty shopping). Treaty shopping is also relevant in the context of tax treaties. For instance U.S. income tax treaties have long included a “limitation on benefits” (LOBs) article analogous to that described above. See Fleming (2012) for a detailed discussion underlying the U.S. rationale for the LOB article.

20

ultimately wholly owned by the U.S. parent, outside ownership cannot explain most of the structures we see. 4.2

Country pair regressions The country pair regressions examine direct ownership connections between two

affiliates located in different countries. The goal is to test the subset of hypotheses in Section 2 that make predictions about characteristics of country pairs. We take the location of each firm’s affiliates as given and ask what characteristics of a country pair – such as the countries’ geographic closeness, economic ties, or treaties in place – affect the likelihood that two affiliates located in these countries have an ownership link. 4.2.1

The setup The unit of observation in these regressions is a country pair. The sample consists of all

pairs that could be formed within a multinational group, given the affiliates in our sample of 792 firm-years with ownership chains (i.e., a country pair is included if there is at least one firm-year with affiliates in each country). The left-hand side variable measures the frequency with which an ownership link involving a country pair occurs in the data. The construction of this variable is best explained using a simple example involving a single firm (we aggregate across firms by summing up individual-firm frequencies). The firm has subsidiaries in three different countries A, B, and C and the number of subsidiaries in each country is NA, NB, and NC. In this single-firm example, the regression would have 6 observations (=32) capturing all possible country pair combinations: AB, AC, BA, BC, CA and CB. The country pair AB denotes a case in which a subsidiary located in country A owns a subsidiary located in country B. The regression estimates the likelihood that a given connection, such as AB, occurs in the data (actual frequency) controlling for the number of times the combination could possibly occur (possible frequency). Taking the AB connection as an example, our main approach assumes that any subsidiary located in country A can own any subsidiary located in country B. Thus the number of possible ownership connections generating the AB link is NANB. To obtain the actual frequency of AB, we count all links of this type occurring in data. Thus for example, if a subsidiary in country B is owned by two different subsidiaries in country A we count it as two separate occurrences of the AB link.

21

As a robustness test, we construct the actual and possible country pairs by considering whether any subsidiary located in country B is owned by any subsidiary located in country A. This method aggregates ownership links that involve multiple owners of the same daughter subsidiary (thus in the example above, we would count only one occurrence of the AB link instead of two). In contrast to the first approach – the alternative method assumes that having more than one subsidiary in country A does not automatically increase the likelihood that a country A subsidiary becomes an owner. This approach also takes into account that some firms may consolidate BEA reporting within a country. Overall, our results are robust to different ways of constructing actual and possible country pairs. We estimate the regressions using a Tobit model to account for the high frequency of zero in the dependent variable. In one specification, the dependent variable is the natural logarithm of one plus the frequency with which the country pair occurs in the data, with the natural logarithm of all possible frequencies included as a control variable. In a separate specification, the frequencies are replaced by total assets of daughter subsidiaries counted in each link that are held by their corresponding owners.22 The explanatory variables measure the characteristics of the country pairs, and we control for country characteristics using two sets of country fixed effects, one for the owner country and one for the daughter country. 4.2.2

The sample and descriptive statistics on country pairs To construct the sample for the country pair regressions, we start with 62,180 country

pairs that occur together at least once within the same firm (in the sense that a firm has subsidiaries in both countries in the same year). This number reduces to 48,728 country pairs, representing 158 countries, because of missing data.23 Of those, 2,079 country pairs have a non-zero value for the number of actual links. Table 4 shows that the average number of actual links in the 2,079 subsample is 3.1 with a median of 1.0. The frequency is highly skewed with the most popular country pairs occurring more than a hundred times. Table 4

22

Our results are robust to using total equity of daughter subsidiaries rather than total assets. They are also robust to using (the natural log of one plus) the ratio of the actual frequency (or assets) to possible frequency (or assets) as the dependent variable. 23 We do not have complete data for 26 countries. As we construct some of our country pair variables from country-level variables, missing data for a single country (i.e., GDP) results in missing observations approximately equal to the total number of countries in our data times three years.

22

also includes descriptive statistics for the independent variables used in the country pair regressions, and the variable definitions are in Appendix D. For a subset of 224 country pairs, Table 5 shows the frequency with which each of the owner-daughter connections occurs in the sample (Panel A), and it also shows the combined assets of the subsidiaries associated with each country pair (Panel B). The country pairs shown in the table are selected as follows. From each of the five major geographic regions, such as Europe, Middle East, or Africa, we select up to 3 countries that most frequently host owner subsidiaries (top owner countries) and up to 3 countries that most frequently host daughter subsidiaries (top daughter countries).24 (The top owner and daughter countries are selected based on the number of owner or daughter subsidiaries in proportion of all subsidiaries located in that country.) The table shows the number of ownership links and the associated assets for each of the owner-daughter country pair. The total number of individual ownership links included in the table is 1,318, and total subsidiary assets involved in these links are $274 billion (approximately 15 percent of assets associated with ownership links in our sample). The most frequent owner country is Netherlands, capturing 641 out of the 1,318 ownership links and accounting for $111 billion of assets. The top owner countries from each of the remaining four regions are Caymans/BVI, Mauritius, Saudi Arabia, and Hong Kong with frequencies ranging from 5 to 73. Although owners in Africa and the Middle East are rare, daughters are more common – 137 in total. The most frequent daughter country from each region is Brazil, France, South Africa, Israel and China ranging from 18 to 265. 4.2.3

Country pair regressions: results The regressions in Table 6 test the subset of hypotheses in Section 2 that make

predictions about characteristics of country pairs. Most importantly, the regressions examine economic ties between subsidiaries (Section 2.2) and tax and investment agreements between countries (Sections 2.3 and 2.4) as explanations for ownership links. The economic ties hypothesis is strongly supported by the data. We instrument for economic interactions between subsidiaries using measures of cultural and historical

24

The 5 regions correspond to those that the BEA uses to report international statistics: Latin America/Atlantic, Europe, Middle East, Africa, and Asia/South Pacific. Canada represents its own region in the BEA data so we include Canada in Table 5 as a top owner country and a top daughter country.

23

connections between their host countries. Specifically, we use dummy variables for common language, a common colonizer, and common religion as well as a measure of geographic distance between countries (see definitions in Appendix D). Based on all four measures, we find that subsidiaries located in countries with stronger economic ties are more likely to have ownership links. Focusing on the left panel of Table 6, the likelihood of an ownership link is higher when the host countries are geographically closer (t-statistic for geographic distance is -16.94), have common official language (t-statistic of 3.72), common religion (t-statistic 2.02), and a common colonizer (t-statistic of 3.22). All results are similar when the dependent variable is constructed using subsidiary assets (the right panel). In addition, we explore two direct measures of economic closeness between countries: bilateral trade flows between two countries relative to their total trade flows, and a dummy variable equal to one if the countries have a preferential trade agreement (PTA). We find that the trade flows are positively associated with the likelihood of an ownership link (t-statistic in the left panel is 5.99), consistent with the importance of economic ties. There is no significant relation between ownership and the existence of a PTA. Our tax variables in Table 6 capture key aspects of multinational tax planning described in Section 2.3, including withholding taxes, tax deferral, and tax treaties. We include separately withholding tax rates on dividends flowing from the owner country to the daughter country and vice versa, and we find that only the relevant withholding tax rate – i.e., that on dividends flowing from the daughter to the owner country – is significantly and negatively associated with the existence of an ownership link (the t-statistic in the left panel is -4.35). The coefficient on the withholding tax rate on dividends flowing in the opposite direction is negative but not statistically significant.25 Turning to the tax deferral strategies, we include the ratio of the income tax rates of the owner country to that of the daughter country to test whether particular strategies – that is, strategies involving a high-tax subsidiary owning a low-tax subsidiary or vice versa – are especially frequent (see Section 2.3). We find that the coefficient on the ratio is positive but not statistically significant in either regression. This may reflect the fact that, as explained in

25

In unreported regressions, we also include withholding tax rates on interest and royalty payments from the daughter country to the owner country, motivated by the tax planning strategies discussed in Grubert (2012), and find that withholding tax rates on dividends and interest load significantly in the regression while withholding taxes on royalty payments is insignificant.

24

Section 2.3, different strategies rely on different configurations of foreign income tax rates within ownership chains. Our results provide no clear evidence that specific strategies, such as those requiring an ‘L-H’ type link, dominate in practice. However, it is possible that statutory tax rates used in these tests are noisy measures of the effective tax rates implicit in the companies’ actual income pools.26 Finally, recognizing that different configurations are possible, in unreported tests, we replace the relative rate with the absolute difference in statutory tax rates between the owner and daughter country and find a negative and significant coefficient on this variable. This finding is puzzling because it suggests that ownership links are more likely between countries with similar statutory tax rates (while the strategies described in Section 2.3.3 all require that the country of the owner has either a higher or a lower tax rate than the country of its daughter subsidiary). The final two tax related findings are that, controlling for other factors, two host countries are more likely to form an ownership link if they have a tax treaty in place and if they are both located in tax havens. The first result suggests that tax treaties have significant net benefits for firms in addition to lowering their withholding tax rates. This finding seems at odds with the earlier result in Table 3 that showed a lower frequency of owners in countries with more extensive tax treaty networks. One explanation for the contradictory findings might be that the extent of a country’s tax treaty network proxies for its more general approach to taxation. For example, tax havens have typically less extensive tax treaty networks and are also favorable locations for owners. Finally, we find that the existence of a bilateral investment treaty (BIT) between two countries makes it more likely that the two countries are connected with an ownership link. The coefficient on the BIT dummy is positive in both regressions and it has a t-statistic of 1.54 in the count regression in the left panel and of 3.06 in the asset regression in the right panel. The stronger result in the asset regression is consistent with BITs being especially important for subsidiaries with significant assets (i.e., when expropriation risk is high).

26

Blouin, Krull, and Robinson (2012) note that the benefit of tax deferral is increasing in the repatriation tax rate, which is a function not of the current tax rate of the affiliate, but rather the “blended” tax rate that characterizes the total pool of undistributed foreign earnings; i.e., the affiliate’s foreign tax credit for purposes of computing it’s U.S. residual tax liability at repatriation depends on the foreign statutory tax rates in effect at the time when income was earned.

25

The control variables in Table 6 include measures of relative GDP, GDP per capita, and property rights associated with the country pair, as well as dummy variables for whether the pair

is part of the OECD and the EU. Consistent with the owner regressions, the coefficients on these controls suggest that property rights and institutional quality are important factors in ownership structure choices.

5

Conclusions This paper analyses internal ownership structures of U.S. multinational firms. Our first

goal is to document the basic characteristics of the structures. We find that firms can take vastly different approaches to internal ownership, with close to 40% of firms in our sample having simple flat structures while other firms being highly complex. Our second goal is to take a step towards understanding these choices by exploring the key forces that drive ownership structures. We start the analysis by putting forward a simple framework for thinking about internal ownership, including the role of taxes, financing, expropriation risks, and historical accidents. We test the importance of these factors in two ways. First, we explore the characteristics of entities that hold equity in other affiliates (owner entities), and second, we examine the properties of entity pairs that are connected through direct (crossborder) ownership links. The analysis yields a number of distinct patterns and highlights the complexity of the tradeoffs involved in designing internal ownership structures. We find that tax considerations play a key role in firms’ internal ownership choices, and that firms appear to optimize several tax objectives simultaneously, including reducing foreign income taxes and withholding taxes, postponing repatriation of profits to the U.S., and avoiding taxes on capital transactions. Moreover, tax planning is only one of several factors that firms consider when making ownership decisions. For example, ownership structures are used to minimize expropriation risks, for example, by taking advantage of the network of bilateral investment treaties (BITs) that protect foreign investors. More generally, we find that a country’s governance plays a key role in internal ownership decisions. Though some attributes of the ownership structures seem to be designed with specific tax or legal goals in mind, other attributes appear to result from a series of past business decisions. For example, firms’ subsidiaries that are older and historically more profitable are more likely to be on the top of ownership chains, consistent with them having provided

26

financing in the past. Also, ownership links are significantly more frequent among subsidiaries that have economic ties with each other, implying that business and financing interactions among business units overlap. In sum, our paper provides a broad picture of how ownership is organized within multinational firms, and it sheds light at the complex tradeoffs involved in internal ownership choices. Understanding these choices is important from a number of policy, tax, and academic perspectives, and the area provides a fruitful ground for future research.

27

6

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Grubert, H. and J. Mutti, 2007. The effect of taxes on royalties and the migration of intangible assets abroad, NBER Working paper 13248. Hallward-Driemeier, M., 2003. Do bilateral investment treaties attract FDI? Only a bit…and they could bite. World Bank Policy Research Paper WPS 3121. World Bank: Washington DC. Hanlon, M., B. Lester, and R. Verdi. 2012. The effect of repatriation tax costs on U.S. multinational investment. MIT working paper. Hassett, K. and R. G. Hubbard, 2002. Tax policy and business investment, in A. J. Auerbach and M. Feldstein (ed.), Handbook of Public Economics, Vol. 3, Elsevier, North-Holland. Hayes, T., 1997. Checkmate, the Treasury Finally Surrenders: The Check-the-Box Treasury Regulations and Their Effect on Entity Classification. Washington and Lee Law Review 54(3).

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Hines, J. and E. Rice, 1994. Fiscal paradise: foreign tax havens and American business. Quarterly Journal of Economics 109, 149. Jansen, J., 2011. International Cash Pooling: Cross-border Cash Management Systems and Intragroup financing. Sellier European Law Publishers, GmbH, Munich. Joint Committee on Taxation (JCT), 1997. Review of selected entity classification and partnership tax issues. U.S. Government Printing Office, Washington, DC. La Porta, R, F. Lopez-de-Silanes, A. Shleifer and R Vishny. 1998. Law and finance. Journal of Political Economy 106, 1113–55. LaPorta, R., F. Lopez-de-Silanes and A. Shleifer, 1999. Corporate ownership around the world. Journal of Finance 54, 471-517. Lipsey, Robert, 2007. Defining and Measuring the Location of FDI Output, NBER Working paper No. 12996. Macovei, A., and M. Rasch, 2011. Tax and strategic management of intangibles. Intellectual Asset Management, PriceWaterhouse Coopers, Luxembourg, March/April. Mintz, J. and A. Weichenrieder, 2010. The indirect side of foreign direct investment: Multinational company finance and taxation. MIT Press, Cambridge. Mundell, R., 1957. International trade and factor mobility. American Economic Review 47, 321. Neumayer, E. and L. Spess, 2005. Do bilateral investment treaties increase foreign direct investment to developing countries? World Development 33, 1567–1585. Tobin, J. and S. Rose-Ackerman, 2004. Foreign direct investment and the business environment in developing countries: The impact of bilateral investment treaties. Yale Law School Center for Law, Economics and Public Policy Research Paper No. 293. United Nations Conference on Trade and Development (UNCTAD), 2012. World Investment Report, 2012. New York and Geneva, United Nations. United Nations Conference on Trade and Development (UNCTAD), 2005. Investor-state disputes arising from investment treaties: a review. UNCTAD series on international investment policies for development. New York and Geneva, United Nations. United States Senate (U.S. Senate), 2012. Exhibits: Hearing on Offshore Profit Shifting and the U.S. Tax Code, September 20, 2012. United States Senate (U.S. Senate), 2003. Report on Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, February. Wilson, J.D., 1999. Theories of tax competition. National Tax Journal 52, 269-304. Wolf, R., 2000. Effective international joint venture management. M.E. Sharpe Inc., New York.

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Appendix A Basic principles of taxation of foreign income Multinational firms are taxed in multiple countries and can be therefore subject to double taxation.27 For example, when a legal entity is owned by a parent company located abroad, the entity’s income is taxed by its host country, but it can be taxed again in the host country of the parent. Although the parent’s host country offers unilateral relief from double taxation, bilateral tax treaties are necessary to resolve double taxation problems that cannot be resolved unilaterally. Depending on the approach to taxation of foreign income, countries tax systems can be broadly categorized as worldwide or territorial. Under a worldwide system, a country taxes its residents on their worldwide income while under a territorial system, it taxes its residents only on their domestic income. Worldwide systems typically provide a relief from double taxation by allowing a tax credit for foreign taxes paid (domestic tax on foreign income is imposed either when the income is earned or when it is repatriated). Alternatively, a worldwide system may exempt foreign dividends from taxation altogether. This latter feature is referred to as a participation exemption, and it is usually conditional on the taxpayer meeting certain criteria.28 Pure worldwide or territorial systems are rare, and most countries are either more territorial or more worldwide in nature (see Clausing and Shaviro (2011)).29 An important feature of both worldwide and territorial tax systems are the so-called anti-abuse mechanisms, which are rules designed to limit tax avoidance.30 For example, resident companies may have incentives to shift income to low-tax host countries of their foreign affiliates, which is especially relevant for mobile income, such as royalties, dividends, or interest payments. Countries use three key anti-abuse mechanisms. First, controlled foreign company (CFC) legislation allows the home country to tax certain foreign income of a resident company – such as mobile income – immediately, regardless of when it is repatriated (or whether it would otherwise fall under a participation exemption). Second, general anti-avoidance legislation gives the taxing authority discretion to redefine a transaction for tax purposes (for example, a debt transaction could be redefined as an equity transaction). Third, thin capitalization rules cap debt-to-equity ratios of resident companies to

27

Detailed descriptions of the aspects of the U.S. and foreign tax systems that are relevant for multinational firms can be found, for example, in Doernberg (2012) and Eicke (2009). 28 For example, the parent could be required to hold a certain minimum equity stake in the subsidiary, or the exemption may be conditional on the existence of a tax treaty between the home country of the subsidiary and the home country of the parent. 29 Note that territorial countries also face double taxation issues and rely on tax treaties to address them. 30 Definitions of abuse differ across countries. In the U.S., the economic substance doctrine, developed by the courts, generally considers a transaction to be abusive when it has no significant economic effect on the taxpayer, other than a reduction of federal income taxes. In such cases, the tax benefit from the transaction can be denied. The economic substance doctrine was codified into Section 7701(o) to the Internal Revenue Code in 2010.

31

limit interest tax deductions the companies can take (see Büttner, Overesch, Schreiber, and Wamswer (2006)).

Taxes other than income taxes Dividends, interest, and royalty payments made to residents of a foreign country are often subject to a withholding tax in the country of the payer. For example, suppose that a subsidiary located in country A makes a dividend payment of $100 to its parent company in country B, and the relevant withholding tax rate is 20%. In this case, the subsidiary owes a tax of $20 in country A. Withholding tax rates vary depending on the country pair and the type of payment, and they can be as high as 35%. Bilateral tax treaties often reduce or eliminate withholding taxes for specific country pairs. Unlike withholding taxes on dividends, those levied on royalties and interest payments generally apply independently of whether the transacting affiliates have a direct ownership connection. Thus tax strategies aimed at reducing these taxes have, in general, no direct implications for ownership structures. However, strategies aimed at reducing withholding taxes on royalties and interest have indirect implications for ownership structures, for example, if hybrid structures are used to achieve U.S. tax deferral on intercompany interest or royalty payments (see the discussion of Subpart F and hybrid structures below).31 In addition to dividends, capital contributions made by one affiliate to another can be subject to a capital duty, and some countries impose a stamp duty on transfer of shares or bonds. Again, the tax rates vary considerably from country to country, and many countries have no capital or stamp duties. These taxes are likely to influence multinational firms’ ownership decisions.

The US tax system and tax deferral The U.S. tax system can be described as worldwide with deferral. It includes no participation exemption for foreign dividends, but it allows a foreign tax credit (FTC) for taxes paid to foreign governments to eliminate double-taxation. Suppose, for example, that a U.S. firm repatriates a certain amount of foreign income in a given year, and that the income has been taxed abroad at an average rate of 25%. At the time of repatriation, the U.S. taxes the foreign income at the rate of 10%, which corresponds to the difference between the U.S.

31

A well-known strategy that uses a specific ownership structure to reduce withholding taxes on royalties (among other things) is the Double Irish strategy, sometimes combined with the Dutch Sandwich strategy. The strategy is used by several U.S. multinationals, and its purpose is to reduce foreign income taxes and withholding taxes on income from sale of intellectual property abroad, while maintaining U.S. tax deferral. The strategy involves an ownership chain spanning Bermuda, Netherlands, and Ireland (from top to bottom) and is set up so that royalty payments flowing from the bottom to the top of the chain are almost untaxed until repatriated to the U.S. Note that for this strategy to work, the U.S. parent must control the Bermuda entity, and the Bermuda entity must control the Irish entity (the Netherlands entity serves as a holding company) in order to qualify for treaty benefits and meet tax residency requirements. Control requires stock ownership greater than 50 percent (see Darby (2007)).

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income tax rate of 35% and the average foreign tax rate. Alternatively, suppose that the average foreign tax rate is 40% rather than 25% (this can occur especially if the foreign earnings were subject to both income and withholding taxes). In this case, the firm owes no U.S. taxes at repatriation, and it accumulates an excess foreign tax credit at the rate of 5%. The excess credit can be carried forward up to five years, and during that period, it can be used to offset U.S. taxes due at any future repatriations. The anti-abuse CFC legislation in the U.S. is referred to as subpart F. It treats certain foreign passive income, in particular cross-border dividends, interest, and royalties, as taxable in the U.S. in the year in which it is earned rather than when it is repatriated. Concretely, if a foreign affiliate of a U.S. multinational receives a dividend payment (or other type of passive income) from another affiliate located in a third country, then this dividend is taxed immediately by the U.S regardless of repatriation. Since ownership chains can generate cross-border dividends between foreign affiliates, they can expose a firm to subpart F. However, subpart F rules can be avoided in a fairly simple manner. This is because the rules apply only to payments occurring between two corporations, and foreign affiliates of a U.S. firm can be classified as either corporations or partnerships for U.S. tax purposes (see JCT, 1997).32 This allows firms to form entities that are treated as corporations in foreign jurisdictions but as partnerships by the U.S. (so-called “hybrid entities”). Any dividends, royalties, or interest payments paid from a partnership to its immediate parent are not subject to subpart F (because they are considered to occur within a single consolidated entity) and are thus not taxed by the U.S. until repatriated.

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The entity classification rules are in Section 7701 of the Internal Revenue Code. The U.S. Treasury and the IRS changed these rules in 1997 by issuing the so-called check-the-box (CTB) regulation. Before CTB, an entity was classified as partnership vs. corporation based on four characteristics, including limited liability, free transferability of interests, and continuity of life. After CTB, eligible entities can elect to be taxed as partnerships (or as disregarded entities if they have a single member) or as corporations. See Appendix C for an example of a deferral structure used by Enron Corporation pre-CTB.

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Appendix B: Dividend repatriation to U.S. involving an ownership chain Two deferral strategies described in prior literature (e.g., in Altshuler and Grubert (2002)) are the so-called triangular strategy and the blending strategy. For brevity, below we denote an ownership connection between two subsidiaries in which the owner is in a highertax country as H-L (and the opposite configuration as L-H). The triangular strategy involves H and L, initially both directly owned by the U.S. parent. The strategy allows L to repatriate its income tax efficiently by channeling it through H. To do so, L purchases equity in H, and at the same time, H passes on the funds to the parent in the form of a dividend. The combined transactions trigger no U.S. taxes assuming that H’s foreign tax rate is at least 35%. The transactions result in an ownership chain with the low-tax subsidiary as the owner (L-H). The blending strategy is more complex. The idea is that lightly taxed income generated by L is channeled up the ownership chain through H in the form of a dividend, and then passed on to the U.S. parent, also as a dividend. In the process, L’s income is blended with the H’s high-tax income pool, so that the resulting U.S. taxes at repatriation are lower than they would be if L paid the dividend directly to the parent.33 Below, we highlight this strategy further on a simple example. Consider a U.S. firm that sets up two subsidiaries A and B abroad. The host countries of the subsidiaries are also denoted A and B, and they have corporate income tax rates tA and tB, respectively. For simplicity, there are no withholding tax rates, and both foreign income tax rates are below 35% so that the dividend payments generate no excess foreign tax credit (FTC) in the U.S. We consider two scenarios: in the first case, the U.S. parent owns both A and B and in the second case, the U.S. parent owns A and A owns B. The parent repatriates an amount of D (after foreign taxes are paid) in a given year, and dA is the fraction originating in country A. The example illustrates how IRS determines the implicit tax rate on D, denoted tC, that is used to compute the foreign tax credit. The higher is this implicit tax rate, the lower is the U.S. income tax paid by the parent upon repatriation of D. The example shows each of the two cases (tiered and flat structure) under different assumptions about the tA vs. tB. Case 1: Subsidiaries A and B are directly owned by the parent To start with, let’s define a grossed-up tax rate, denoted t’, as the tax rate that, when multiplied by the amount of the repatriated dividend, it produces the foreign tax credit that the dividend carries. So for country A, the grossed-up tax rate is: (1) In the first case we consider, subsidiaries A and B are directly owned by the parent, and each subsidiary makes pays a dividend to the parent in the same year. The IRS determines the foreign tax credit associated with the payments as:

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Because this strategy generates cross-border dividends, Altshuler and Grubert (2002) note it requires that subpart F does not apply to these dividend payments (see the discussion Appendix A).

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1

(2)

Thus the implicit grossed-up tax rate that the US applies to D is: 1

(3)

It is simply a weighted average of the grossed-up tax rates of countries A and B where the weight is the proportion of the country’s dividend on the total dividend paid in that year. Case 2: The parent owns A and A owns B Suppose that the bottom subsidiary B makes a payment (1-d1)D to country A, and country A passes on this payment to the parent, and in addition it also pays d1D, so that the total flow to the parent is D as in the previous case. We assume that country A does not tax the dividend from B. The goal is, again, to determine t’C applied on the total payment D by the IRS. The added complication is that the amount of FTC the IRS will apply depends on the average tax rate in the A’s pool of retained earnings after B makes the dividend to A. Suppose that the tax rate in the A’s earnings pool before B pays the dividend is tA to match our assumption in Case 1. Thus the first step is to determine how the dividend from B will affect this tax rate. This depends on the size of the dividend from B to A relative to the size of the A’s earnings pool. Let’s denote as f the ratio of the dividend from B to A to the size of A’s after-tax earnings pool prior to the dividend: ∗



(4)



Thus the total income in the pool (TIP) and the total taxes accumulated in the pool (TTP) after B makes the dividend are: (5) .

(6)

Consequently, the grossed-up tax rate applied by the IRS to a dividend payment made from the pool after B’s dividend to A is: (7) Thus t’C does not depend on the fraction of the total dividend flow originating in each sub (this is because this fraction affects both the earnings pool and the tax pool of A, and the two effects offset). However, t’C depends on how large the B’s dividend is relative to the A’s earnings pool. The larger is the dividend in relation to the pool, the larger is the weight of t’B in determining t’C. Comparing the two cases The two implicit grossed-up tax rates for cases 1 and 2, denoted below as DIR for direct ownership and TIER for tiered ownership, are:

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1

(8) (9)

The question is under what conditions the parent pays lower taxes at repatriation of D by using the tiered structure. Suppose first that the entire dividend payment originates from . It turns out that the grossed up tax rate on D will be lower as B, so that dA=0 and long as country A has a higher tax rate than country B. This is because by channeling B’s to the B’s dividend through A, the parent can apply the blended grossed-up tax rate dividend payment, which in this case would be higher than . Suppose next that A pays out all earnings in its pool together with the dividend from B. In this case: Substituting

(10) 1

/

into eq. (9) yields:

(11) Thus in this example the parent can reduce repatriation taxes on current dividends using a chain with the bottom subsidiary located in a lower-tax jurisdiction than the top subsidiary. The tax benefit of the tiered structure comes from the fact that the dividends paid by the lowtax subsidiary are channeled through the high-tax earnings pool of the top subsidiary, resulting in a higher blended tax rate used to compute the foreign tax credit.

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Appendix C: U.S. tax deferral involving an ownership chain

Fig. A: Enron’s tax deferral strategy (reproduced from U.S. Senate (2003))

This appendix is based on U.S. Senate (2003, pgs. 373-382) and illustrates Enron’s use of a complex ownership structure for its foreign infrastructure development business from 1991 through 2000. Fig. A shows that when Enron conducts an infrastructure project in a foreign country it sets up a Host Country Project (HCP) entity in that country. In addition, Enron creates an ownership chain connecting HCP to the parent that involves three separate entities in Cayman Islands, two of which are created for each project that Enron pursues while the third is designated as the owner for this line of business. The tax purpose of this structure is twofold. First, Enron wants to distribute income from the project to its foreign entities without generating U.S. income tax under Subpart F. Enron wanted to distribute income from the project for two reasons: (1) the distributions from one project entity could finance other project entities, and (2) certain project entities were located in risky countries making it undesirable to leave the earnings in the host country. Second, Enron also wants to structure a potential future sale of the project in a tax efficient manner. This appendix focuses on describing how Enron achieves the first objective (i.e., the tax efficient distribution of income from HCP). In general, a distribution of income from one foreign entity of a U.S. firm to another is subject to Subpart F (i.e., is taxed immediately by the U.S) if the entities are located in two different countries. However, Subpart F can be avoided if the entity making the distribution is treated as a partnership for U.S. tax purposes. The Enron structure follows this approach. The

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two bottom entities in the structure, the Host Country Project (HCP) entity and the Cayman Islands Limited (CIL) entity, are corporations in their respective host countries but are treated as partnerships in the U.S. for tax purposes. The use of the upper and lower tier entities as owners of CIL insures that CIL is treated as partnership by the IRS. As a result of this structure, income generated by HCP can be channeled to the top of the chain without invoking Subpart F. The only distributions that are subject to Subpart F are distributions from the lower-tier to the upper-tier entity. However, given that the lower-tier entity owns only 1% of CIL, these distributions are likely small. Note that, although CIL is located in the same country as its owners (i.e., in Cayman Islands), the same-country exception to Subpart F does not apply to distributions from CIL because the entity is not engaged in active business (instead, it owns another operating entity (HCP) located in a different country). This explains why it is necessary that CIL is also set up as a partnership to avoid Subpart F. The passage of the so-called check-the-box (CTB) regulations in 1997 made it easier to achieve partnership classification for U.S. tax purposes by allowing a single-member Limited Liability Company (LLC) to be treated as a disregarded entity (not taxed separately from its owners). Prior to 1997, there was an uncertainty about the tax treatment of single-member LLC, and some tax experts recommended forming multiple-member LLCs to ensure partnership status (see, for example, Hayes (1997)). U.S. Senate (2003) notes that with the introduction of these new regulations, Enron could have achieved its U.S. tax deferral objectives without the lower-tier entity or CIL, but that the use of CIL was still desirable for non-tax reasons.

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Appendix D: Variable definitions Subsidiary descriptive statistics and regressions Subsidiary characteristics Total Assets Operating Assets Total Sales Age 3-yr avg. ROA 3-yr avg. sales growth R&D /Total Sales PPE/Operating Assets Cash/Operating Assets Total Liabilities/Total Equity Effective Tax Rate Historical Outside Ownership # Same Firm Subs in Region # Same Firm Subs in Industry % Intercompany Sales Country characteristics Log GDP Log GDPPC Property Rights Statutory Tax Rate OECD Member EU Member Tax Haven

Total subsidiary assets (not in the regression). Total subsidiary assets minus investment in affiliated entities (enters the regression logged). Total subsidiary sales (not in the regression). The number of years since the year the affiliate first began filing a BEA survey or 1982, whichever comes later (enters the regression logged). The average return on assets (ROA) over the prior three years for the subsidiary’s country-industry, using the BEA’s 12 industry groups. The average sales growth over the prior three years for the subsidiary’s country-industry, using the BEA's 12 industry groups. Total subsidiary R&D expenditures/Total subsidiary sales. Total subsidiary PPE/Total subsidiary operating assets. Total subsidiary cash and other current assets (excluding inventory and receivables) /Total subsidiary operating assets. Total subsidiary liabilities/Total subsidiary equity. Estimate of the foreign rate of tax paid on the subsidiary's total pool of undistributed earnings (see Blouin, Krull, and Robinson (2012)) Dummy variable equal one if the subsidiary has outside ownership. The number of subsidiaries of the same firm that operate in the same region. The measure uses seven BEA regions that largely correspond to continents (enters the regression logged). The number of subsidiaries of the same firm that operate in the same 2-digit industry code (enters the regression logged). The proportion of total subsidiary sales to affiliates on total subsidiary sales.

Gross Domestic Product (GDP) of the host country from the World Bank (enters the regression logged). GDP per capita of the host country from the World Bank (enters the regression logged) Property rights index of the host country from Andrei Shleifer’s website. Statutory tax rate of the host country from KPMG Taxation and Investment Guides and Ernst & Young Worldwide Corporate Tax Guides. Dummy variable equal to one if the host country was part of OECD prior to 1990 from OECD website. Dummy variable equal to one if the host country is part of the EU from the EU website. Dummy variable equal to one if the host country is tax haven as defined in Hines and Rice (1994). Tax havens are: Hong Kong, Ireland, Lebanon, Liberia, Panama, Singapore, Switzerland, Andorra, Anguilla, Antigua and Barbuda, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Caymans Islands, Channel Islands (Jersey, Guernsey, Alderney), Cyprus, Dominica, Gibraltar, Grenada, Isle of Man, Liechtenstein,

39

Investment Treaty Network

Tax Treaty Network Withholding Tax on Dividends Worldwide Taxation

CFC Legislation Thin Capitalization Rules General Anti-Avoidance Rules Capital and/or Stamp Duty

Luxembourg, Macao, Maldives, Malta, Marshall Islands, Monaco, Netherlands Antilles, Saint Kitts and Nevis, Saint Lucia, Saint Vi ncent and Grenadines, and Vanuatu. The total number of bilateral investment treaties (BITs) that the country has in effect plus the number of bilateral relationships resulting from free trade agreements (FTAs) with investment clauses. Only FTAs with investment clauses containing the word “arbitration” are included. Data on BITs come from UNCTAD, and data on FTAs come from the World Bank. The total number of bilateral tax treaties that the host country has in effect, obtained from OECD (enters the regression logged). The average withholding tax rate on dividends flowing to the host country from other countries, obtained from Comtax. These rates reflect treaty reductions, if any. Dummy variable equal to one if the country operates a worldwide tax system with no participation exemption for foreign dividend income, obtained from Deloitte & Touche Country Tax Guides. Dummy variable equal to one if the country has controlled foreign corporation legislation; Comtax and Deloitte & Touche (D&T) Country Tax Guides. Dummy variable equal to one if the country has thin capitalization legislation; Comtax and (D&T) Country Tax Guides. Dummy variable equal to one if the country has a statutory general antiavoidance rule; Comtax and D&T Country Tax Guides. Dummy variable equal to one if the country has both capital and stamp duties; Comtax and D&T Country Tax Guides.

Country pair descriptive statistics and regressions Actual frequency

Actual assets Possible frequency

Possible assets

Common language Log(distance) Colonial link Relative GDP Pair with high GDP

Number of times a country pair A-B appears in our sample as a host country of an owner subsidiary (A) and a host country of its direct daughter subsidiary (B). See details in Section 4.2.1. Total assets associated with a country pair A-B computed as assets of all subsidiaries in country B held by subsidiaries in country A (in millions). Number of different ownership connections that could be formed for a country pair A-B using subsidiaries located in the two countries. This quantity is computed by multiplying, for each firm, the number of entities located in country A by the number of entities in country B, and then summing up this figure across all firms. See details in Section 4.2.1. Total assets associated with different ownership connections that could be formed for a count pair A-B using subsidiaries located in two different countries. This amount is computed by multiplying for each firm, total assets of entities located in country A by total assets of entities in country B, and then summing up this figure across all firms. See details in Section 4.2.1. Dummy variable equal to one if both countries in the pair have the same official language, obtained from CEPII. Natural log of geodesic weighted distance (km) between countries in the pair; CEPII. Dummy variable equal one if the countries in the pair ever had a colonial link; CEPII. GDP in possible owner country/(GDP in possible owner country + GDP in possible daughter country) Dummy variable equal one if GDP in both countries in the pair are in the top

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Relative GDPPC Pair with high GDPPC Relative property rights

Pair with high prop. rights Pair in OECD Pair in EU Pair in tax havens Trade flows (bilateral to total)

Trade agreement

BIT dummy

Tax treaty Withholding tax rate B to A Withholding tax rate A to B Relative tax rate

quartile of the distribution of GDP. GDP per capita in possible owner country/(GDP per capita in possible owner country + GDP per capita in possible daughter country) Dummy variable equal one if GDP per capita in both countries in the pair are in the top quartile of the distribution of GDP per capita. Property rights index in possible owner country/(Property rights index in possible owner country + Property rights index in possible daughter country); high Property rights index implies strong property rights. Dummy variable equal one if property rights index in both countries in the pair are in the top quartile of the distribution of property rights index. Dummy variable equal to one if both countries in the pair were members of the OECD in 1990. Dummy variable equal to one if both countries in the pair are members of the EU. Dummy variable equal to one if both countries in the pair are tax havens. Bilateral trade flows between the countries in the pair relative to their total trade flows. This quantity is computed in three steps: (1) First, we take the ratio of total exports from the possible owner country to the possible daughter country divided by total exports of the possible owner country, and we do the same for imports; (2) Second, we take the ratio of total exports of the possible daughter country to the possible owner country divided by total exports of the possible daughter country, and we do the same for imports; (3) We average the four ratios. The trade flow data comes from UNCTAD. Dummy variable equal to one if the countries in the pair have any of the following types of agreements in effect: customs union agreement, economic union agreement, free trade area agreement, non-reciprocal preferential trade agreement, preferential trade agreement. The data come from Jeff Bergstrand’s website. Dummy variable equal to one if the countries in the pair have a bilateral investment treaty or a free trade agreement with an investment clause that contains the word “arbitration” in effect. Dummy variable equal to one if the countries in the pair have a bilateral tax treaty in effect. Withholding tax rate on dividend payments made from the possible daughter country to the possible owner country. These rates reflect treaty reductions, if any. Withholding tax rate on dividend payments made from the possible owner country to the possible daughter country. These rates reflect treaty reductions, if any. Statutory tax rate in owner country/(Statutory tax rate in owner country + Statutory tax rate in daughter country).

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Table 1: Descriptive data for multinational firm-years with and without ownership chains. The initial sample consists of 1,278 firm-years which represent 634 unique firms. The sample period includes 1994, 1999, and 2004. Effective tax rate is total tax expense divided by pre-tax earnings. % Intercompany Sales (Foreign) is total intercompany sales between foreign subsidiaries divided by total foreign sales. Owners are subsidiaries that hold equity in other affiliated entities. Direct Daughter Subs are subsidiaries in which Owners have a direct equity interest. All Daughter Subs are subsidiaries in which Owners have a direct or indirect equity interest. Holdco are Owners classified as holding companies. The definition of a holding company is in Section 3.2, footnote 10. Top Tier subsidiaries are those in which the U.S. parent has a direct equity interest. Dollar amounts are in millions. In order to avoid disclosure of information on individual companies, medians are reported as the mean of the five middle values.

Characteristics of Multinational Firm Operations Worldwide Assets Foreign Assets % Foreign Assets Worldwide Return on Assets Worldwide Effective Tax Rate % Intercompany Sales (Foreign) # Countries # Industries # Subsidiaries Years Abroad Characteristics of Multinational Firm Owner Subsidiaries Number of Owners Avg.# Direct Daughter Subs per Owner Max # Direct Daughter Subs per Owner Avg. # of All Daughter Subs per Owner Number of Holdco Avg. # Direct Daughter Subs per Holdco Max # Direct Daughter Subs per Holdco Avg. # of All Daughter Subs per Holdco Owners/Total Subs Top Tier Owners/Total Top Tier Subs # Holdco/#Owners

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Firm-years without ownership chains N=486 Mean Med

Firm-years with ownership chains N=792 Mean Med

4,333 1,444 35.16 4.74 33.02 10.03 14.87 2.46 19.48 11.40

23,207 10,685 45.59 4.20 28.49 16.98 24.08 7.06 55.27 13.75

3,661 1,537 45.36 4.02 29.13 13.52 19.20 5.00 33.00 13.00

7.23 2.47 6.45 3.61 3.01 2.81 5.41 4.89 0.15 0.19 0.37

3.00 2.00 4.00 2.50 1.00 2.00 3.00 3.00 0.13 0.14 0.33

835 264 32.99 4.43 34.07 3.33 12.00 2.00 15.00 12.80

Table 2 Panel A: Descriptive data for subsidiary-years by location within ownership structure. This panel shows descriptive data for 33,051 subsidiaries based upon their position within an ownership structure. A chain is a path within an ownership structure connecting a bottom subsidiary (i.e., a subsidiary that does not hold equity in another subsidiary) to the parent. Variable definitions are in Appendix D. Dollar amounts are in millions, unless otherwise noted. In order to avoid disclosure of information on individual companies, medians are reported as the mean of the five middle values. Non-chain Subs Med

Top of chain Mean Med

Chain Subs Middle of chain Mean Med

12.53 12.53 11.82 4.00 0.04 0.06 0.00 0.00 0.13 0.06 0.64 0.00 0.00 24.00 28.00 0.00

464.70 177.81 259.16 66.04 138.03 10.35 8.84 7.00 0.05 0.05 0.05 0.04 0.00 0.00 0.18 0.00 0.11 0.00 0.06 0.03 1.45 0.48 0.16 0.04 0.07 0.00 50.72 27.00 28.38 14.00 0.12 0.00

552.20 292.56 156.29 7.72 0.05 0.06 0.00 0.18 0.11 0.06 1.52 0.17 0.06 83.37 38.83 0.14

182.36 69.71 9.09 6.00 0.04 0.05 0.00 0.00 0.00 0.02 0.44 0.04 0.00 50.50 25.00 0.00

135.49 125.10 87.39 6.19 0.05 0.08 0.00 0.12 0.22 0.07 2.39 0.20 0.34 71.31 45.77 0.10

Country Characteristics GDP ($ Billion) GDP per Capita ($ Thousand) Property Rights Statutory Tax Rate OECD Member EU Member Tax Haven Investment Treaty Network Tax Treaty Network Withhold. Tax on Dividends Worldwide Taxation CFC Legislation Thin Capitalization Rules General Anti-Avoid. Rules Capital and/or Stamp Duty

657.28 287.26 15.94 19.20 5.72 7.00 0.25 0.28 0.50 0.00 0.29 0.00 0.14 0.00 41.82 31.00 48.80 50.00 0.04 0.04 0.41 0.00 0.52 1.00 0.69 1.00 0.80 1.00 0.20 0.00

643.54 370.47 23.40 23.39 6.61 7.00 0.23 0.28 0.74 1.00 0.51 1.00 0.31 0.00 52.94 59.00 54.39 56.00 0.03 0.03 0.19 0.00 0.41 0.00 0.74 1.00 0.83 1.00 0.08 0.00

728.88 22.79 6.57 0.24 0.74 0.55 0.25 58.61 56.00 0.03 0.25 0.47 0.74 0.85 0.08

402.92 23.43 7.00 0.27 1.00 1.00 0.00 69.00 69.00 0.03 0.00 0.00 1.00 1.00 0.00

779.75 370.47 17.49 20.16 6.00 7.00 0.26 0.28 0.62 1.00 0.40 0.00 0.13 0.00 48.45 44.00 54.54 56.00 0.03 0.03 0.35 0.00 0.54 1.00 0.72 1.00 0.81 1.00 0.19 0.00

N

20,686

Mean Subsidiary Characteristics Total Assets Operating Assets Total Sales Age 3-yr avg. ROA 3-yr avg. sales growth R&D /Total Sales (%) R&D dummy PPE/Operating Assets Cash/Operating Assets Total Liabilities/Total Equity Effective Tax Rate Historical Outside Ownership Indicator # Same Firm Subs in Region # Same Firm Subs in Industry % Intercompany Sales

82.30 82.30 54.60 5.93 0.05 0.08 0.00 0.10 0.20 0.07 1.89 0.17 0.15 49.57 47.08 0.07

1,767

43

1,688

Bottom of chain Mean Med

8,910

22.88 22.47 21.90 4.00 0.04 0.07 0.00 0.00 0.12 0.06 0.99 0.11 0.00 38.00 30.00 0.00

Table 2 Panel B: Descriptive data for subsidiary-years by location within ownership structure. This panel shows descriptive data for 3,455 owner subsidiaries (i.e., subsidiaries that hold equity in another subsidiary). The owner subsidiaries are split into holding company owner and operating owner subsamples. The definition of a holding company is in Section 3.2, footnote 10. Variable definitions are in Appendix D. Dollar amounts are in millions, unless otherwise noted. In order to avoid disclosure of information on individual companies, medians are reported as the mean of the five middle values. Holding owners Mean Med

Operating owners Mean Med

Subsidiary Characteristics Total Assets Operating Assets Total Sales Age 3-yr hist. avg. ROA 3-yr hist. avg. sales growth R&D /Total Sales (%) R&D dummy PPE/Operating Assets Cash/Operating Assets Total Liabilities/Total Equity Effective Tax Rate – Hist. Outside Ownership Indicator # Same Firm Subs in Region # Same Firm Subs in Industry % Intercompany Sales

576.27 181.74 162.22 6.07 0.04 0.04 0.00 0.00 0.02 0.07 0.84 0.07 0.04 67.16 20.65 0.00

205.70 21.84 0.00 4.00 0.04 0.01 0.00 0.00 0.00 0.02 0.05 0.00 0.00 39.50 11.00 0.00

459.54 340.73 249.14 9.84 0.05 0.07 0.01 0.30 0.17 0.05 1.93 0.23 0.08 66.34 42.40 0.22

163.26 113.86 93.57 9.00 0.05 0.06 0.00 0.00 0.09 0.03 0.87 0.19 0.00 37.00 26.00 0.03

Country Characteristics GDP ($ Billion) GDPPC ($ Thousand) Property Rights Statutory Tax Rate OECD Member EU Member Tax Haven Investment Treaty Network Tax Treaty Network Withhold. Tax on Dividends Worldwide Taxation CFC Legislation Thin Capitalization Rules General Anti-Avoid. Rules Capital and/or Stamp Duty

597.70 24.79 6.69 0.21 0.72 0.55 0.35 57.57 56.35 0.03 0.19 0.36 0.73 0.85 0.05

370.47 24.10 7.00 0.23 1.00 1.00 0.00 65.00 62.00 0.03 0.00 0.00 1.00 1.00 0.00

768.34 21.96 6.52 0.26 0.78 0.53 0.21 56.60 60.18 0.03 0.24 0.52 0.76 0.84 0.10

402.92 22.56 7.00 0.28 1.00 1.00 0.00 61.00 66.00 0.03 0.00 1.00 1.00 1.00 0.00

N

1,418

44

2,037

Table 3: Logistic regressions estimating the likelihood that a subsidiary is an owner. An owner is a subsidiary that owns equity in other affiliates. An operating owner is an owner that is not classified as a holding company by the BEA. The definition of a holding company is in Section 3.2, footnote 10. The benchmark sample is non-chain subsidiaries, i.e., entities that are not part of a cross-border ownership chain, such as entities C, D, F in Fig. 2. Standard errors are clustered by firm. Variable definitions are in Appendix D. We report marginal effects (me) for Panel A. The marginal effects show the change in the likelihood of being an owner that is associated with a one-standard deviation increase in the dependent variable (or an increase from zero to one for dummy variables) at the mean of all variables. A: All owners vs. Non-chain subs

B: Operating owners vs. Non-chain subs coef. z-stat

C: Holding vs. operating owners coef. z-stat

coef.

z-stat

me

Subsidiary characteristics Log Operating Assets Log Age 3-yr hist. avg. ROA 3-yr hist. avg. sales growth PPE/Operating Assets R&D /Total Sales Cash/Operating Assets Total Liab./Total Equity Effective Tax Rate - Hist. Outside Ownership # Same Firm Subs in Region # Same Firm Subs in Industry % Intercompany Sales

0.34 0.35 -0.59 -1.75 -2.22 14.00 -0.45 -0.12 -0.52 -0.50 0.42 -0.27 -0.13

14.04 8.33 -0.74 -6.30 -10.67 3.67 -0.67 -9.47 -4.01 -3.02 6.22 -5.81 -0.96

0.051 0.020 0.001 -0.014 -0.030 0.006 -0.001 -0.023 -0.011 0.022 0.021 -0.022 -0.002

0.37 0.21 0.26 -0.49 -0.88 28.90 -3.90 -0.07 -0.22 -0.21 0.15 0.13 0.97

12.92 5.20 0.41 -1.88 -4.62 8.27 -4.42 -6.35 -2.01 -1.65 2.41 2.46 6.66

-0.49 -0.30

-10.36 -3.51

0.13 -0.15 -3.60 -0.60 -0.05

0.13 -5.70 -7.25 -2.30 -0.31

Country characteristics Log GDP Log GDPPC Property Rights Statutory Tax Rate OECD Member EU Member Tax Haven Investment Treaty Network Tax Treaty Network Withhold. Tax on Div. Worldwide Taxation CFC Legislation Thin Capitalization Rules General Anti-Avoid. Rules Capital and/or Stamp Duty

-0.01 0.25 0.08 -1.06 0.31 0.52 0.30 0.16 -0.22 -14.89 -0.31 -0.01 0.04 0.26 -0.80

-0.29 3.87 1.90 -2.42 1.99 5.31 2.16 2.83 -3.24 -3.67 -3.47 -0.09 0.45 2.86 -6.23

-0.004 0.021 0.008 -0.011 0.024 0.030 0.013 0.016 -0.023 -0.012 -0.018 -0.005 0.015 0.010 -0.046

0.02 0.08 0.04 -1.07 0.24 0.35 0.27 0.21 -0.07 -5.54 -0.19 -0.06 -0.06 -0.04 -0.48

0.40 1.58 1.08 -3.16 1.63 3.79 1.98 3.92 -1.27 -1.53 -2.19 -0.83 -0.69 -0.47 -5.08

-0.02 0.45 0.18 -1.92 0.04 0.50 0.16 -0.04 -0.41 -27.08 0.10 0.14 0.68 0.82 -1.41

-0.20 3.17 1.86 -1.24 1.17 2.55 0.50 -0.35 -3.44 -2.44 0.51 0.66 2.50 3.93 -4.55

Firm and year fixed effects N owner N benchmark

Y 3,455 20,686

Y 2,037 20,686

45

Y 1,418 2,037

Table 4: Descriptive data for country pairs. The table shows descriptive data for country pairs used in regressions reported in Table 6. A country pair AB denotes a host country of a potential owner subsidiary (A) and a host country of its potential daughter subsidiary (B). The sample includes all country pairs that occur at least once as host countries of subsidiaries of the same firm (i.e., can potentially have an ownership link). In the left panel are 48,728 country pairs that could potentially form an ownership link, while in the right panel are 2,079 country pairs with at least one actual ownership link. Details are in Section 4.2.1. Variable definitions are in Appendix D. Dollar amounts are in millions, unless otherwise noted.

Actual frequency Actual assets Log(1Actual frequency) Log(1Actual assets) Log(1+Possible frequency) Log(1+Possible assets) Same religion Common Language Log(distance) Colonial link Pair in OECD Pair in EU Relative GDP (A/(A+B)) Pair with high GDP Relative GDPPC (A/(A+B)) Pair with high GDPPC Relative prop. rights (A/(A+B)) Pair with high property rights Trade flows (bilateral to total) Trade agreement dummy BIT dummy Tax treaty dummy Withholding tax rate B to A Withholding tax rate A to B Relative tax rate (A/(A+B)) Pair in tax havens

Pairs with possible ownership links Mean Med Std 0.13 0.00 1.19 35.27 0.00 740.62 0.05 0.00 0.26 0.48 0.00 2.32 2.75 2.56 1.92 23.73 23.75 4.50 0.08 0.00 0.28 0.17 0.00 0.37 8.72 8.94 0.81 0.02 0.00 0.15 0.03 0.00 0.17 0.02 0.00 0.13 0.50 0.50 0.38 0.37 0.00 0.48 0.50 0.50 0.34 0.07 0.00 0.26 0.50 0.50 0.19 0.10 0.00 0.30 0.00 0.00 0.00 0.49 0.00 0.49 0.16 0.00 0.36 0.18 0.00 0.38 0.04 0.00 0.08 0.04 0.00 0.08 0.50 0.50 0.32 0.02 0.00 0.16

N

48,728

Pairs with actual ownership links Mean Med Std 3.05 1.00 4.90 826.62 71.24 3,493.94 1.13 0.69 0.61 11.22 11.17 2.33 5.87 6.05 1.52 30.31 30.56 3.17 0.14 0.00 0.35 0.25 0.00 0.44 8.07 8.26 1.12 0.08 0.00 0.27 0.32 0.00 0.47 0.16 1.00 0.37 0.50 0.52 0.36 0.68 1.00 0.47 0.65 0.64 0.23 0.44 0.00 0.50 0.55 0.50 0.12 0.45 0.00 0.50 0.01 0.00 0.01 0.64 1.00 0.48 0.27 0.00 0.45 0.52 1.00 0.50 0.05 0.00 0.08 0.05 0.00 0.08 0.44 0.48 0.29 0.07 0.00 0.26 2,079

46

Caymans/BVI

Panama

Bermuda

Netherlands

Germany

U.K.

Mauritius

Egypt

Israel

Saudi Arabia

Hong Kong

Singapore

South Korea

Sum

U.S. (direct)

Owner (top) / daughter (side) Canada Brazil Mexico Bermuda France Italy Germany South Africa Nigeria Morocco Israel UAE Saudi Arabia China Singapore Japan Sum

Canada

Table 5 Panel A: Country pairs with direct ownership links (actual frequency): The table shows the actual frequency of direct ownership connections in our sample between subsidiaries located in 14 host countries of owner subsidiaries and 16 host countries of daughter subsidiaries. “na” means not applicable as our focus is on ownership links between two different countries. The U.S. appears as an owner for comparison amounts represent direct ownership connections from the U.S. to subsidiaries in the daughter country. Details are in Section 4.2.2.

na 22 6 3 9 7 15 1 0 0 0 1 0 3 0 8 75

0 16 5 0 1 4 2 4 3 1 3 0 0 9 12 8 68

1 8 4 0 2 1 4 3 0 0 0 0 2 2 8 4 39

2 6 3 na 5 1 4 4 11 2 0 0 4 6 9 3 60

32 27 24 8 138 139 127 39 0 2 19 4 1 21 18 42 641

6 6 5 2 62 24 na 3 0 0 0 0 0 11 3 14 136

8 2 3 2 47 37 44 16 2 0 1 4 0 1 8 10 185

0 0 0 0 0 0 0 0 0 0 0 0 1 6 1 0 8

0 0 0 0 0 0 0 0 2 0 0 0 2 0 0 2 6

1 0 0 0 1 0 3 0 0 0 0 0 0 0 0 0 5

0 0 0 7 0 0 0 0 0 0 0 0 na 0 0 0 7

1 1 0 2 0 0 0 0 0 0 0 0 2 48 12 7 73

0 0 1 3 0 0 0 0 0 0 0 0 0 12 na 4 20

1 0 0 0 0 0 1 0 0 0 0 0 0 4 0 0 6

52 88 51 27 265 213 200 70 18 5 23 9 12 123 71 102 1,329

1,960 781 1,204 585 1,605 1,920 905 436 107 44 117 136 156 806 734 1,301 12,797

47

Caymans/BVI

Panama

Bermuda

Netherlands

Germany

U.K.

Mauritius

Egypt

Israel

Saudi Arabia

Hong Kong

Singapore

South Korea

Sum

U.S.

Owner (top) / daughter (side) Canada Brazil Mexico Bermuda France Italy Germany South Africa Nigeria Morocco Israel UAE Saudi Arabia China Singapore Japan Sum

Canada

Table 5 Panel B: Country pairs with direct ownership links (actual assets in $millions): The table shows actual assets associated with the direct ownership connections from Panel A. These are assets in subsidiaries in the daughter country held by subsidiaries in the owner country. “na” means not applicable as our focus is on ownership links between two different countries. “D” means that the value of assets for the given ownership connection is suppressed to avoid disclosure of data of individual companies. The U.S. appears as an owner for comparison and amounts represent assets in subsidiaries in the daughter country held by the U.S. parent directly. Details are in Section 4.2.2.

na 4,795 39 D 636 643 1,977 D 0 0 0 D 0 D 0 17,475 29,238

0 D 490 0 D D D 134 D D D 0 0 D 1,315 D 51,723

D 287 119 0 D D 693 D 0 0 0 0 D D 1,768 2,649 7,051

D 1,609 D na 1,483 D 58 29 1,428 D 0 0 18 1,722 5,524 D 12,311

6,265 3,069 5,366 13,527 25,141 12,990 28,890 1,540 0 D 1,026 97 D 2,884 3,140 7,909 111,860

622 311 490 D 2,710 679 na D 0 0 0 0 0 189,461 D 4,255 9,223

172 D D D 6,495 2,848 21,864 684 D 0 D 255,292 0 D 4,492 7,662 44,634

0 0 0 0 0 0 0 0 0 0 0 0 D 806 D 0 843

0 0 0 0 0 0 0 0 D 0 0 0 D 0 0 D 130

D 0 0 0 D 0 D 0 0 0 0 0 0 0 0 0 637

0 0 0 D 0 0 0 0 0 0 0 0 na 0 0 0 147

D D 0 D 0 0 0 0 0 0 0 0 D 1,913 999 395 4,899

0 0 D D 0 0 0 0 0 0 0 0 0 527 na 764 1,443

D 0 0 0 0 0 D 0 0 0 0 0 0 D 0 0 270

7,560 16,145 6,478 17,046 38,624 17,964 56,305 2,618 1,899 748 2,123 395 1,069 8,856 17,292 79,289 274,410

1,728,991 124,689 133,063 1,205,388 487,485 294,739 1,162,128 11,549 7,152 754 25,169 7,740 25,113 30,932 110,679 1,879,655 7,235,227

48

Table 6: Tobit regressions estimating the likelihood that a country pair forms an ownership link. A country pair AB denotes a host country of a potential owner subsidiary (A) and a host country of its potential daughter subsidiary (B). The sample includes all country pairs that occur at least once as host countries of subsidiaries of the same firm (i.e., can potentially have an ownership link). In the left panel, the dependent variable is the natural logarithm of the number of actual ownership links associated with the country pair (actual frequency). In the right panel, the dependent variable is the natural logarithm of the assets associated with each ownership link (actual assets). These are assets of the daughter subsidiaries in country B owned by subsidiaries in country A (zero if there is no ownership link for that country pair). The regressions control for the natural logarithm of the possible frequency of ownership links (left panel) or of the corresponding assets (right panel). Details are in Section 4.2.1. Variable definitions are in Appendix D. Standard errors are clustered by country pair. We report marginal effects at the means of all dependent variables for the probability of being uncensored (puc) and for the expected value conditional on being uncensored (cev). As an example, a one unit increase in Same religion implies a 0.59% increase in the probability that we observe at least one ownership link between two countries. Also, a one unit increase in Same religion implies a 1.07% increase in the number of observed ownership links between two countries, for the 2,079 uncensored observations.

Possible frequency or assets Same religion Common Language Log(distance) Colonial link Pair in OECD Pair in EU Relative GDP (A/(A+B)) Pair with high GDP Relative GDPPC (A/(A+B)) Pair with high GDPPC Relative prop. rights (A/(A+B)) Pair with high property rights Trade flows (bilateral to total) Trade agreement dummy BIT dummy Tax treaty dummy Withholding tax rate B to A Withholding tax rate A to B Relative tax rate (A/(A+B)) Pair in tax havens Constant Log likelihood Year fixed effect Owner country fixed effect Daughter country fixed effect N

coef. 0.40 0.14 0.20 -0.47 0.27 0.53 0.06 0.04 0.23 0.43 0.23 6.49 0.05 12.04 -0.02 0.08 0.13 -1.35 -0.38 0.16 0.34 -2.94 -4842.1 Y Y Y 48,728

Actual frequency z-stat puc .0169 13.93 .0059 2.02 .0083 3.72 -.0197 -16.94 .0113 3.22 .0223 5.35 .0028 0.95 .0018 0.28 .0096 1.50 .0183 1.32 .0098 3.05 .2749 3.12 .0022 0.63 .5102 5.99 -.0009 -0.44 .0034 1.54 .0055 2.71 -.0572 -4.35 -.0160 -1.34 .0067 1.28 .0144 3.48 -2.65

cev .0304 .0107 .0150 -.0355 .0203 .0401 .0050 .0033 .0172 .0329 .0176 .4942 .0040 .9170 -.0016 .0061 .0098 -.1028 -.0288 .0120 .0259

Actual assets coef. z-stat 1.37 12.12 2.27 3.04 1.99 3.42 -4.90 -16.20 2.56 2.81 5.09 4.76 0.51 0.65 0.86 0.52 2.47 1.51 2.05 0.58 3.08 3.56 68.92 2.91 0.35 0.38 55.76 2.37 0.11 0.20 1.73 3.06 1.84 3.51 -13.63 -3.94 -1.13 -0.37 1.83 1.38 3.08 2.92 -46.17 -3.53 -9982.9 Y Y Y 48,728