1. business and industrial
2. company
3. earnings

What Do Firms Do With The Cash From Tax Savings?
David A. Guenther, Brian M. Williams
Lundquist College of Business, University of Oregon, Eugene, OR 97403 USA
Kenneth Njoroge
Henry B. Tippie College of Business, University of Iowa, Iowa City, IA 52242 USA
April 2015
Abstract: We investigate what firms do with cash from tax savings. Our approach is based on
the identity between sources and uses of cash reflected in the cash flow statement, and we
separate operating cash flow into pretax cash flows and cash payments for taxes. We estimate a
system of five regression equations to measure cash used for investments, cash savings,
dividends, changes in debt, and changes in equity. Our results show firms use cash savings from
taxes less for new investments and dividends and more to pay down debt. We also find that
multinational firms use cash from tax savings to make new investments more than domestic
firms, even when the firms appear to have cash "trapped" in foreign countries.
JEL classification: G31; H20
Key Words: Tax Avoidance; Cash Holdings; Real Investment; Multinational Corporations
Corresponding author:
Professor David A. Guenther
Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403-1208
Phone: (541) 346-5384
Fax:
(541) 346-3341
email: [email protected]
Funding from the Finance and Securities Analysis Center at the Lundquist College of Business is
gratefully acknowledged. Brian Williams gratefully acknowledges funding from the University
of Oregon Research Fellowship. We thank workshop participants at Arizona State University for
helpful comments on a prior version.
What Do Firms Do With The Cash From Tax Savings?
1. Introduction
A fundamental question in public finance economics is how the corporate income tax
affects investment. For example, Djankov et al. (2010) use extensive tax survey data from
PricewaterhouseCoopers to estimate the relation between effective corporate tax rates and fixed
capital investment as a percentage of GDP across eighty-four countries for 2004. In this study
we provide evidence related to this question using a microeconomic approach, by estimating the
sources of cash used for tax payments for a sample of U.S. corporations. If corporate income
taxes affect investment, then our expectation is that cash used for tax payments should decrease
firms' investments, or correspondingly cash generated from tax savings should increase
investments.
Our research question is also important in understanding how tax avoidance by
corporations affects firm risk, a concept generally referred to in the accounting literature as "tax
risk" (Guenther, Matsunaga and Williams 2015). The tax risk literature suggests that corporate
tax avoidance is a risky activity, resulting in such things as higher interest rates, higher cost of
capital, and a greater use of stock options to incent managers to engage in risky activities. We
believe the question of how tax avoidance affects risk depends to a large extent on what firms do
with the cash that is being saved. Putting the saved cash in the bank is hardly going to increase
the firm's risk, whereas paying the saved cash out as dividends or stock repurchases may in fact
make the firm more risky. The answer to our research question — what do firms do with cash
from tax savings — can also provide evidence to help in understanding the link between tax
avoidance and firm risk.
2
Our research question is of particular interest because of the recent focus on the large
amounts of foreign cash being accumulated by U.S. multinationals. While economic theory
suggests that taxes should affect investment, multinationals appear to have plenty of cash
available for investment, and any cash related to reduced foreign tax payments may simply be
accumulated by the firm as cash or marketable securities. 1 In recent years the cash balances of
U.S. corporations have increased dramatically, and academic studies such as Foley et al (2007)
as well as the financial press (Fleischer 2012) argue that tax repatriation costs for U.S.
multinationals play a substantial role in this increase.
To examine how firms use cash from tax savings, we borrow an approach from the
finance literature used by Chang, Dasgupta, Wong and Yao (2014), who estimate how firms
allocate internally generated cash among a variety of uses. Although Chang et al. focus on aftertax operating cash flows, we apply their methodology after decomposing operating cash flows
into pretax and tax components, and we estimate separately the impact that each component has
on different uses (investment, cash savings, and dividends) and sources (borrowing or equity) of
cash.
Our results demonstrate that, on average, firms tend to use cash savings from taxes less
for new investments and dividends and more to pay down debt, which seems inconsistent with
the argument that lower tax payments cause a firm to become more risky. We also find that
multinational firms appear to use cash from tax savings to make new investments more than do
domestic firms, even when the firms appear to have cash "trapped" in foreign countries due to
1
We recognize that firms often hold their cash in “equivalent securities” such as short-term US treasuries. In this
paper we measure cash as cash and equivalents, and use the terms “cash” and “cash and equivalents”
interchangeably.
3
the potential U.S. repatriation tax. Thus, our results do not suggest that multinational firms with
trapped foreign cash are underinvesting due to U.S. tax rules.
Our results make an important first step in helping to understand what public companies
do with their tax-related cash flows. Better understanding how cash from tax savings is used will
help researchers to better understand both the impact that taxes have on the riskiness of firms, as
well as how taxes affect new investment. The effects of the corporate income tax on investment
and risk are fundamental public policy question that have long been of interest to researchers.
The innovation of our paper is that by estimating how cash from tax savings are used we can
provide empirical evidence related to these questions.
Our paper also makes an important contribution to the tax avoidance literature and
increases our understanding of corporate tax avoidance. While many studies examine various
determinants of tax avoidance, we are unaware of any study that examines how firms actually
use the cash that is generated from avoiding corporate income taxes. Our approach increases our
understanding of why firms may avoid corporate income taxes, and the potential effect of this tax
avoidance on various firm characteristics and production possibilities.
2. Methodology
2.1 The basic model
We follow the approach outlined in Chang et al. (2014) to estimate the uses of internally
generated cash flows. The starting point is the cash flow identity from the cash flow statement,
defined as:
𝐼𝐼𝐼𝐼𝐼𝐼𝑡𝑡 + ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑡𝑡 + 𝐷𝐷𝐷𝐷𝐷𝐷𝑡𝑡 − ∆𝐷𝐷𝑡𝑡 − ∆𝐸𝐸𝑡𝑡 = 𝐶𝐶𝐶𝐶𝑡𝑡 ,
(1)
4
where the uses of cash include net new investment (Inv), the net increase in cash holdings
(∆Cash) and the payment of cash dividends (Div). Sources of cash can be either internal or
external. External sources of cash are the issuance of new debt, net of debt repayments, (∆D)
and the issuance of new equity, net of stock repurchases (∆E). Internally generated cash is cash
flow from operations (CF). As expressed in Equation (1), the total sources of cash are
CF + ∆D + ∆E. However, it is possible for either (or both) ∆D and ∆E to be negative, in which
case CF + (-∆D) + (-∆E) represents the net source of cash after repayment of debt (-∆D) and
stock repurchases (-∆E).
We regress the different uses of cash (Inv, ∆Cash, etc.) on operating cash flow (CF) and a
set of control variables. 2 We estimate a system of five regression equations as follows:
𝐼𝐼𝐼𝐼𝐼𝐼𝑖𝑖𝑖𝑖 = 𝛽𝛽 𝐼𝐼𝐼𝐼𝐼𝐼 𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝛾𝛾 𝐼𝐼𝐼𝐼𝐼𝐼 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖𝐼𝐼𝐼𝐼𝐼𝐼 ,
(2)
𝐷𝐷𝐷𝐷𝐷𝐷𝑖𝑖𝑖𝑖 = 𝛽𝛽 𝐷𝐷𝐷𝐷𝐷𝐷 𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝛾𝛾 𝐷𝐷𝐷𝐷𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖𝐷𝐷𝐷𝐷𝐷𝐷 ,
(4)
∆𝐸𝐸𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐸𝐸 𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝛾𝛾 ∆𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐸𝐸 .
(6)
∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝛾𝛾 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ ,
∆𝐷𝐷𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐷𝐷 𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖 + 𝛾𝛾 ∆𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐷𝐷 ,
(3)
(5)
The coefficient on CF represents how operating cash flow is used on average across the five
different sources and uses of cash. Because all of the sources and uses of cash reflected in
Equation (1) have to equal operating cash flow (i.e., Equation (1) is an identity) all of the
coefficients on CF have to sum to one. Mathematically this means that the coefficients in
Equations (2) through (6) must satisfy the following constraints:
2
We also include firm and year fixed effects, and scale all variables by total assets at the beginning of the year.
Note that all of the control variables are measured as of the prior year, time t-1.
5
and
𝛽𝛽 𝐼𝐼𝐼𝐼𝐼𝐼 + 𝛽𝛽 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ + 𝛽𝛽 𝐷𝐷𝐷𝐷𝐷𝐷 + 𝛽𝛽 ∆𝐷𝐷 + 𝛽𝛽 ∆𝐸𝐸 = 1,
𝛾𝛾 𝐼𝐼𝐼𝐼𝐼𝐼 + 𝛾𝛾 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ + 𝛾𝛾 𝐷𝐷𝐷𝐷𝐷𝐷 + 𝛾𝛾 ∆𝐷𝐷 + 𝛾𝛾 ∆𝐸𝐸 = 0.
(7)
(8)
According to Chang et al. (2014, 3633) "the adding up constraint (7) reflects the
accounting identity that sources of cash equal uses of cash. In other words, a one-dollar increase
in internal cash flow needs to be used to increase investment, increase cash holding, pay
dividends, or reduce outstanding debt or equity." Constraint (8) stipulates "that the total
response across different sources and uses of funds must sum to zero if the shock stems from an
exogenous or predetermined variable that represents neither a source or use of funds in the
current period." Here is how Chang et al. explain the constraint in (8): Suppose the coefficient
on Controls is 0.1 in Equation (2), suggesting that investment increases by 10% of total assets if
Controls increases by one. Because investment is a use of cash and total uses of cash must be
equal to the total sources of cash, the net effect of the increase in Controls on other use variables
must sum to -10% of total assets.
According to Chang et al. (2014, 3633), if the variables in Equation (1) are consistently
defined so that the cash flow identity holds implicitly in the data, constraints (7) and (8) "should
hold automatically and need not be imposed explicitly in the estimation. Furthermore, Equations
(2) – (6) can be estimated simultaneously using seemingly unrelated regressions (SUR), because
each equation in the system has its own dependent variable and the explanatory variables in all
equations are either exogenous or predetermined. Greene (2012) suggests that SUR estimates
are equivalent to equation-by-equation OLS estimates if the same set of explanatory variables is
included in each equation, which is precisely the case in Equations (2) – (6)." Chang et al.
confirm this result in their study by estimating equations (2) – (6) simultaneously using SUR and
imposing constraints (7) and (8).
6
2.2 Separating cash payments for taxes
To investigate how cash payments for taxes affect firms' uses of cash flows, we modify
the model from Chang et al. (2014) by separating operating cash flows into their pretax and tax
components as follows:
𝐶𝐶𝐶𝐶𝑡𝑡 = 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑡𝑡 − 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 ,
(9)
where PTCF is pretax cash flows and TAX is cash paid for taxes. 3 Using this approach, we
modify Equations (2) – (6) as follows:
𝐼𝐼𝐼𝐼𝐼𝐼𝑖𝑖𝑖𝑖 = 𝛽𝛽 𝐼𝐼𝐼𝐼𝐼𝐼 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 − 𝛿𝛿 𝐼𝐼𝐼𝐼𝐼𝐼 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 + 𝛾𝛾 𝐼𝐼𝐼𝐼𝐼𝐼 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖𝐼𝐼𝐼𝐼𝐼𝐼 ,
(2')
𝐷𝐷𝐷𝐷𝐷𝐷𝑖𝑖𝑖𝑖 = 𝛽𝛽 𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 − 𝛿𝛿 𝐷𝐷𝐷𝐷𝐷𝐷 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 + 𝛾𝛾 𝐷𝐷𝐷𝐷𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖𝐷𝐷𝐷𝐷𝐷𝐷 ,
(4')
∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 − 𝛿𝛿 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 + 𝛾𝛾 ∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐶𝐶𝐶𝐶𝐶𝐶ℎ ,
∆𝐷𝐷𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 − 𝛿𝛿 ∆𝐷𝐷 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 + 𝛾𝛾 ∆𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐷𝐷 ,
∆𝐸𝐸𝑖𝑖𝑖𝑖 = 𝛽𝛽 ∆𝐸𝐸 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 − 𝛿𝛿 ∆𝐸𝐸 𝑇𝑇𝑇𝑇𝑇𝑇𝑡𝑡 + 𝛾𝛾 ∆𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑖𝑖𝑖𝑖−1 + 𝜀𝜀𝑖𝑖𝑖𝑖∆𝐸𝐸 .
(3')
(5')
(6')
These equations form the basis for our empirical tests. The coefficients on TAX can be
interpreted as reflecting how an additional $1 of cash flow resulting from lower tax payments
would be allocated across the other sources and uses of cash.
3
Note that TAX is not the same as tax expense. Firms are required to report as supplemental cash flow information
the amount of cash paid for taxes, and this is captured by Compustat data item TXPD.
7
3. Sample and results
3.1 Variable measures
Our initial sample consists of all firms with data on Compustat necessary to compute our
regression variables. The cash flow variables used in Equations (2) – (6) are computed as
follows (with Compustat data names shown in parentheses):
Investment (Inv) = Investing activities net cash flow (ivncf) scaled by lagged
assets (at),
Change in Cash (∆Cash) = Change in cash and cash equivalents (chech) scaled by
lagged assets (at),
Dividends (Div) = Cash dividends (dv) scaled by lagged assets (at),
Change in Debt (∆D) = Long-term debt issuance (dltis) – long-term debt reduction
(dltr) + changes in current debt (dlcch) + financing
activities – other (fiao),
Change in Equity (∆E) = Sale of common and preferred stock (sstk) – purchase of
common and preferred stock (prskc) scaled by lagged
assets (at), and
Cash Flow (CF) = Operating cash flow (oancf) + exchange rate effect (exre)
scaled by lagged assets (at).
We also compute a variable equal to the difference between the left and right sides of Equation
(1) as follows: (Inv+∆Cash+Div–∆D–∆E) – (CF). This should equal zero for a perfectly
specified equation. We require this measure to be within 0.01 for an observation to be included
in our sample. This results in a final sample size of 29,651. Descriptive statistics for the sample
variables are presented in Table 1.
8
===========
Insert Table 1
===========
The control variables used in our regressions are taken from Chang et al. (2014) and are
measured as follows:
MB = Market value of assets scaled by total book assets (at), where market
value of assets is equal to the market value of equity plus the book
value of debt, and market value of equity is equal to price per share
times number of shares outstanding,
Sales Growth = (Current sales (sale) – lagged sales) / lagged sales,
Ln(Assets) = Natural log of assets (at),
Leverage = [Long term debt (dltt) plus short term debt (dlc) ] scaled by lagged
assets, and
Tangibility = Net property, plant, and equipment (ppent) scaled by lagged assets.
All control variables are measured as of the prior year, time t-1. Because of our focus on tax
payments, we also include two additional control variables not used by Chang et al. (2014) as
follows:
NOL / Assets = Tax loss carryforwards (tlcf) scaled by lagged assets. This variable is
set to 0 if missing data on tax loss carryforwards, and
Pretax Income / Assets = Pretax income (pi) scaled by lagged assets (at).
3.2 Results
Our first set of results, using the entire sample, are presented in Table 2. We present
results using CF, after-tax operating cash flow, as a benchmark measure with which to compare
9
our results after separating CF into its pretax (PTCF) and tax (TAX) components. To make
comparison of the pretax and tax coefficients easier, we multiply TAX by -1 so that a larger value
of both PTCF and TAX corresponds to a higher cash flow. We also measure all of our variables
so that the signs are consistent with Equation (1). In other words, the ∆D and ∆E variables are
measured so that increasing borrowing or equity (a source of cash) is a positive number and
repayment of debt or stock repurchases are a negative number. Because of the large number of
regressions and variables reported, we do not report coefficients from the control variables in the
tables, although all of our regressions contain control variables as well as firm and year fixed
effects.
===========
Insert Table 2
===========
We first point out that the coefficients on CF from our five regressions reported in
Table 1 are 0.208 + 0.317 + 0.015 – (-0.294) – (-0.127) = 0.961, which is quite close to the
theoretical value of 1.0. The difference is due to the fact that our cash flow identity Equation (1)
does not hold exactly for our sample due to minor items that are on the cash flow statement but
not captured in our variables (e.g., tax benefit from stock option exercises). While we impose a
data screen to eliminate any observations for which this difference is larger than 0.01, it does
affect our results in a small way.
The Table 1 results for CF can be interpreted as follows: for every $1 of operating cash
flow the firm generates, it spends $0.21 on new investments, saves $0.32 as additional cash, pays
$0.02 in dividends, repays $0.29 of debt, and repurchases $0.13 of stock. 4
4
The corresponding amounts from Table 3 in Chang et al. (2014) are 0.28, 0.33, 0.01, -0.28 and -0.10 respectively.
10
When we separate operating cash flows into their pretax and tax components, the
corresponding percentages for the TAX component are: 0.159, 0.315, -0.046, -0.412 and -0.142
respectively. These amounts are similar to the CF results for the change in cash (0.315 vs.
0.317) and the change in equity (-0.142 vs. -0.127). Firms apparently use cash from tax savings
less to make new investments, as the coefficient on TAX is 0.159 whereas the coefficient on
pretax cash flow PTCF is 0.203. Similarly, firms use cash from tax savings to pay down debt
(-0.412) more than they use pretax cash flows (-0.295) for that purpose. Surprisingly, our results
suggest that firms with cash flow related to tax savings pay less in dividends, reflected in the
negative coefficient on dividends (-0.046). 5
We interpret our Table 1 results as having important implications for the "tax risk"
literature that argues that firms with low cash effective tax rates are engaging in a risky activity.
For lower tax payments to be considered risky, one important determinant should be what the
firm does with the cash saved from the tax avoidance activities. Our results in Table 2 suggest
that saving cash from taxes leads to more debt repayment and less investment and dividends,
which in our opinion doesn't cause the firm to become more risky.
3.3 Results based on partitioning sample
For the balance of our empirical tests, we estimate our five regressions separately after
partitioning our sample along various dimensions. Our first partition, reflected in Table 3, is to
separate firms based on whether they are paying more or less tax in the current year than they did
in the prior year. We split the sample based on firms' effective tax rates (ETR), with Panel A
(Panel B) reporting results for firms with an ETR that is greater than (less than) the prior year's
5
Recall that our variables are all measured so that investments, cash savings and dividends are a use of cash. The
negative coefficient suggests a reduction in dividend payments.
11
ETR. Because we are focused on cash flows, we measure ETRs in a particular way for this
purpose, defining the ETR as cash taxes paid divided by pretax operating cash flows.
===========
Insert Table 3
===========
The first Table 3 result we discuss is the difference in the coefficient on TAX for
investments, which is 0.274 for firms that experienced a decrease in ETR compared with 0.167
for firms that experienced an increase in ETR. This suggests that firms may be more likely to
invest cash from tax savings into new investments when the savings is unexpected. A second
result is that the negative coefficient for dividends is present for both types of firms, suggesting
that the impact of tax savings on dividend payment doesn't seem to depend on whether the firm
experienced an increase or decrease in taxes for the year.
In Table 4 we split the sample into those firms that report no foreign income (Panel A)
and those firms reporting foreign income (Panel B). Although we acknowledge our partition
proxy is a crude one and subject to considerable error, we nevertheless find it useful to consider
the Panel B firms to represent "multinational" firms, whereas the Panel A firms represent
"domestic" firms.
===========
Insert Table 4
===========
The Table 4 results demonstrate that the multinational firms in Panel B both invest more
cash and save more cash than the domestic firms in Panel A, and this applies to both the pretax
cash flows and cash related to taxes. Offsetting this, the domestic firms in Panel A pay more
dividends, repay more debt, and repurchase much more stock (-0.14 vs. -0.08 for CF). Both
types of firms exhibit the negative coefficient on dividends related to TAX that was noted in the
12
other tables. The coefficient on change in equity for the TAX variable for multinational firms
(Panel B) is positive but not significantly different from zero, suggesting that more cash from tax
savings for these firms has no effect on stock repurchases, a somewhat surprising result.
To further investigate the results for the multinational firms in the sample, in our final
partition we separate the multinational firms from Table 4 Panel B into two groups based on
whether they are affected by a potential additional U.S. tax on the repatriation of foreign cash to
a U.S. parent, as discussed by Foley et al. (2007). For each sample firm we use the reported
Compustat amounts for pretax income-foreign and tax expense-foreign to compute an estimated
foreign effective tax rate. We separate the multinational firms into those with a foreign ETR that
is greater than (less than) the thirty-five percent statutory U.S. corporate tax rate and report the
results in Panel A (Panel B). We expect that the observations in Panel B face an additional U.S.
tax on repatriation of cash to a U.S. parent, and therefore their cash may be "trapped" outside of
the U.S. as permanently reinvested earnings.
===========
Insert Table 5
===========
We continue to find that for both types of firms the coefficient on dividends for TAX is
negative, and we also find that for both types of firms the coefficient on change in equity for
TAX is not significantly different from zero. We also note that the coefficient for TAX on the
change in cash is much larger for the firms facing a U.S. repatriation tax in Panel B (0.475 vs.
0.363). This additional cash being saved appears to come from lower dividend payments and
stock repurchases, which would be consistent with the "trapped cash" argument. Interestingly,
there doesn't appear to be any difference in the coefficient for TAX on investments, and both are
much higher than for domestic firms in Table 4 Panel A. This suggests that even if U.S. tax laws
13
are causing multinationals to accumulate cash, it does not seem to be at the expense of new
investment.
4. Conclusion
Our study is the first to our knowledge to attempt to answer the question: what do firms
do with cash from tax savings? The answer to this question is important for two reasons. First,
economic theory suggests that taxes affect investment, and our results can provide some
empirical evidence on the extent to which that seems to be happening for U.S. public companies.
Second, there is a debate in tax accounting research about the extent to which low corporate tax
payments, as evidenced by low cash effective tax rates, reflect "risky" activities. The answer to
that question depends in part on understanding what managers of public companies do with the
taxes that the firm is saving. Our results provide evidence to help answer that question.
To estimate what happens to tax-related cash flows we rely on a model from Chang et al.
(2014) that identifies what firms do with operating cash flow. We modify this model by
separating operating cash flow into pretax cash flows and cash payments for taxes. We estimate
a system of five regression equations to measure cash used for investments, cash savings,
dividends, changes in debt, and changes in equity.
Our results demonstrate that, on average, firms tend to use cash savings from taxes less
for new investments and dividends and more to pay down debt, which seems inconsistent with
the argument that lower tax payments cause a firm to become more risky. We also find that
multinational firms appear to use cash from tax savings to make new investments more than do
domestic firms, even when the firms appear to have cash "trapped" in foreign countries due to
14
the potential U.S. repatriation tax. Thus, our results do not suggest that multinational firms with
trapped foreign cash are underinvesting due to U.S. tax rules.
We believe our results make an important first step in helping to understand what public
companies do with their tax-related cash flows. Better understanding how cash from tax savings
is used will help researchers to better understand both the impact that taxes have on the riskiness
of firms, as well as how taxes affect new investment.
15
Appendix A: Variable Definitions
Investment (Inv)
Change in Cash (∆Cash)
Dividends (Div)
Change in Debt (∆D)
Change in Equity (∆E)
Cash Flow (CF)
MB
Sales Growth
Ln(Assets)
Leverage
Tangibility
NOL / Assets
Pretax Income / Assets
Uses of Cash Equation
Investing activities, net cash flow (ivncf) scaled by lagged
assets (at)
Change in cash and cash equivalents (chech) scaled by
lagged assets (at)
Cash dividends (dv) scaled by lagged assets (at)
Long-term debt issuance (dltis) – long-term debt reduction
(dltr) + changes in current debt (dlcch) + financing activities
– other (fiao)
Sale of common and preferred stock (sstk) – purchase of
common and preferred stock (prskc) scaled by lagged assets
(at)
Operating cash flow (oancf) + exchange rate effect (exre)
scaled by lagged assets (at)
Control Variables (all measured as of the prior year)
Market value of assets scaled by total book assets (at)
(Current sales (sale) – lagged sales) / lagged sales
Natural log of assets (at)
[Long term debt (dltt) plus short term debt (dlc) ] scaled by
lagged assets
Net property, plant, and equipment (ppent) scaled by lagged
assets
Tax loss carryforwards (tlcf) scaled by lagged assets. This
variable is set to 0 if missing data on tax loss carryforwards
Pretax income (pi) scaled by lagged assets (at)
16
References:
Chang, X., S. Dasgupta, G. Wong and J. Yao. 2014. Cash-flow sensitivities and the allocation of
internal cash flow. Review of Financial Studies 27; 3628-3657.
Djankov, S., T. Ganser, C. McLiesh, R. Ramalho and A. Shleifer. 2010. The Effect of
CorporateTaxes on Investment and Entrepreneurship. American Economic Journal:
Macroeconomics 2: 31-64.
Fleischer, V. 2012. Overseas Cash and the Tax Games Multinationals Play. New York Times. 3
October 2012.
Foley, C., J. Hartzell, S. Titman and G. Twite. 2007. Why Do Firms Hold So Much Cash? A
Tax-Based Explanation. Journal of Financial Economics 86: 579-607.
Greene,W. 2012. Econometric analysis, 7th edition. Upper Saddle River: Prentice-Hall.
Guenther, D., S. Matsunaga and B. Williams. 2015. Do Low Tax Rates Reflect Risky Tax
Avoidance? Working paper, University of Oregon.
17
Table 1: Descriptive Statistics
Variable
Investment (Inv)
Change in Cash (∆Cash)
Dividends (Div)
Change in Debt (∆D)
Change in Equity (∆E)
Cash Flow (CF)
Variable
MB
Sales Growth
Ln(Assets)
Leverage
Tangibility
NOL / Assets
Pretax Income / Assets
29,651
29,651
29,651
29,651
29,651
29,651
Panel A: Uses of Cash Equation
Mean
Std. Dev.
0.079
0.124
0.007
0.094
0.013
0.027
0.011
0.096
0.012
0.094
0.076
0.134
29,651
29,651
29,651
29,651
29,651
29,651
29,651
Panel B: Control Variables
Mean
Std. Dev.
1.509
1.300
0.098
0.284
5.465
2.320
0.199
0.206
0.264
0.218
0.167
0.591
0.047
0.178
Obs
Obs
Min
Max
-0.275
-0.316
0.000
-0.267
-0.200
-0.440
Min
0.567
0.376
0.171
0.438
0.578
0.433
Max
0.237
-0.566
0.006
0.000
0.006
0.000
-0.704
8.193
1.442
12.757
0.998
0.899
4.347
0.490
18
Table 2: Base Results, Full Sample:
CF/AT
PTCF/AT
-1*TAX/AT
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
Change in equity (-)
0.208
0.317
0.015
-0.294
-0.127
(32.37)
(58.92)
(15.14)
(-56.64)
(-26.99)
0.203
0.313
0.014
-0.295
-0.127
(31.71)
(58.21)
(13.66)
(-57.00)
(-27.07)
0.159
0.315
-0.046
-0.412
-0.142
(5.35)
(12.66)
(-9.80)
(-17.20)
(-6.53)
All variables are defined in Appendix A. The number of observations in each regression is 29,651. All regressions also contain all
control variables and both firm and year fixed effects. t-statistics in parentheses.
19
Table 3: Split on paying more or less tax – based on ETR
CF/AT
PTCF/AT
-1*TAX/AT
CF/AT
PTCF/AT
-1*TAX/AT
Panel A: Paying More Taxes (ETR this year > ETR last year)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.227
0.363
0.015
-0.268
(22.13)
(43.67)
(9.31)
(-33.44)
0.222
0.359
0.014
-0.271
(21.54)
(43.03)
(8.08)
(-33.76)
0.167
0.371
-0.043
-0.393
(3.95)
(10.86)
(6.35)
(-11.97)
Change in equity (-)
-0.093
(-13.29)
-0.094
(-13.41)
-0.132
(-4.59)
Panel B: Paying Less Taxes (ETR this year < ETR last year)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.236
0.360
0.017
-0.298
(21.91)
(41.42)
(9.48)
(-34.52)
0.236
0.357
0.015
-0.300
(21.70)
(40.66)
(8.12)
(-34.38)
0.274
0.301
-0.059
-0.358
(5.52)
(7.50)
(-7.02)
(-8.98)
Change in equity (-)
-0.058
(-8.11)
-0.058
(-8.15)
-0.097
(-2.96)
All variables are defined in Appendix A. The number of observations in each regression is 13,450 in Panel A and 11,633 in Panel B.
All regressions also contain all control variables and both firm and year fixed effects. t-statistics in parentheses.
20
Table 4: Split on domestic or multinational – does the firm have any foreign income
CF/AT
PTCF/AT
-1*TAX/AT
CF/AT
PTCF/AT
-1*TAX/AT
Panel A: No Foreign Income (Domestic Corp.)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.193
0.304
0.016
-0.300
(24.81)
(45.46)
(12.60)
(-47.10)
0.189
0.298
0.015
-0.301
(24.27)
(44.70)
(11.68)
(-47.41)
0.119
0.263
-0.038
-0.438
(3.16)
(8.16)
(-6.01)
(-14.27)
Change in equity (-)
-0.140
(-23.33)
-0.141
(-23.57)
-0.208
(-7.21)
Panel B: Non-Zero Foreign Income (MultiNational Corp)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.248
0.363
0.013
-0.275
(20.93)
(38.42)
(7.64)
(-29.53)
0.245
0.365
0.011
-0.278
(20.59)
(38.38)
(6.19)
(-29.70)
0.266
0.436
-0.067
-0.354
(5.38)
(11.05)
(-9.46)
(-9.09)
Change in equity (-)
-0.080
(-10.34)
-0.078
(-10.03)
0.015
(0.48)
All variables are defined in Appendix A. The number of observations in each regression is 17,652 in Panel A and 11,999 in Panel B.
All regressions also contain all control variables and both firm and year fixed effects. t-statistics in parentheses.
21
Table 5 – Split on Repatriation Tax – Within Sample that has non-zero foreign income (Panel B of Table 4)
CF/AT
PTCF/AT
-1*TAX/AT
CF/AT
PTCF/AT
-1*TAX/AT
Panel A: No Repatriation Tax (foreign etr > 0.35)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.215
0.381
0.024
-0.282
(10.19)
(23.26)
(7.57)
(-16.72)
0.214
0.383
0.020
-0.284
(10.04)
(23.15)
(6.50)
(-16.70)
0.269
0.363
-0.049
-0.340
(5.38)
(23.15)
(-4.00)
(-5.17)
Change in equity (-)
-0.068
(-5.30)
-0.065
(-4.99)
-0.022
(-0.44)
Panel B: Repatriation Tax (foreign etr < 0.35)
Dependent variable in each regression (expected sign)
Investment (+)
Change in cash (+)
Dividends (+)
Change in debt (-)
0.263
0.356
0.009
-0.272
(24.81)
(30.62)
(4.14)
(-24.23)
0.260
0.357
0.006
-0.275
(18.06)
(30.61)
(3.18)
(-24.44)
0.265
0.475
-0.073
-0.365
(4.26)
(9.46)
(-8.28)
(-7.53)
Change in equity (-)
-0.085
(-8.78)
-0.084
(-8.61)
0.041
(0.99)
All variables are defined in Appendix A. The number of observations in each regression is 4,015 in Panel A and 7,984 in Panel B.
All regressions also contain all control variables and both firm and year fixed effects. t-statistics in parentheses.
22