Downside of corporate inversions

“Overall, our study documents significant tax benefits to inversion,” says Radhakrishnan (Radha) Gopalan, associate professor of finance at Olin. American companies that undergo an inversion incorporate in countries with lower effective tax rates, which can lead to higher cash balance, lower dividend payout and fewer stock repurchases.

But there’s a downside to inversion too, Gopalan and his fellow researchers found. Past studies have shown that greater intensity and quality of market analysis contributes to higher profits. Overseas companies in general are followed less regularly by market analysts and these companies tend to have lower stock liquidity. In turn, the market appears to put a lower value on the cash on the firm’s balance sheet.

The study, “Corporate Inversions and Americanizations: A Case of Having the Cake and Eating it Too?” is co-authored by Armando Gomes, PhD, associate professor of finance at Olin, and Felipe Cortes, PhD, of Northwestern University. It appears on the Social Sciences Research Network website.

Return on investment is one area that must be monitored closely in an inversion.

“Firms with foreign incorporation had more cash on their balance sheet and paid less dividends than U.S. firms,” Gopalan said.

“Going into the study, we believed one of the advantages of inversion was the ability to return cash to shareholders without any repatriation tax,” he said. “Our results showed that on average, foreign incorporated firms did not return more cash to shareholders.

“We believe this could partly be because the inverted firms are discounted by the market due to fears about the corporate law in their new country of incorporation, and, in anticipation, the firms may be retaining more cash.”

The researchers however, don’t see an immediate end to the recent swell of inversions.

“While we document some costs in terms of lower stock market valuation from foreign incorporation, for established firms that don’t anticipate raising equity capital from the market, the cost may be limited,” Gopalan said. “So, we do think that the number of inversions may continue.”

– Neil Schoenherr, WUSTL Newsroom

Image: Chris, Flickr, Creative Commons

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