Tax incentives of corporate mergers and foreign direct investments

The objective of this thesis is to investigate how tax systems affect two aspects of corporations\u27 investment decisions: mergers and foreign direct investments. The first part addresses the question of the relative importance of tax incentives for mergers and acquisitions. A theoretical analysis identifies asymmetries in the tax system, e.g., lack of loss offset and rules against share repurchases, as conducive for mergers. Other features, such as preferences for capital gains over dividends and taxation of capital gains only on realization, or so called lock in effects , also bias the tax system in favor of mergers over new investments. An empirical study of the Swedish manufacturing industry is performed. The direct tests give only weak support for a major importance of the tax motive for mergers. However, larger companies have been able to use their tax deductions more efficiently than smaller firms, and have therefore a lower cost of capital. This is an indication of a pro-merger bias of the Swedish tax system. The second part considers the role of tax incentives in the localization decision of multinational companies. It is argued that if countries do not cooperate explicitly in tax rate setting, the result will be an inefficient allocation of the world\u27s capital stock. Governments may engage in competition to attract foreign direct investments by lowering their effective tax rates. There is in this situation a gain to explicit tax coordination. If countries are of unequal size the game may be one of follower-leader type, with the largest country being a leader. The empirical results, on Swedish data, indicate that the Swedish effective corporate tax rate has adjusted quickly to changes in the average effective tax rates abroad. This endogeneity of tax rates makes it difficult to establish an independent role for tax incentives as attractors of foreign direct investments. Some support for this hypothesis in the case of the U.S. is received, however. The U.S. is also identified as a leader of the tax setting game during the sample period