TAX POLICY AND THE MULTINATIONAL FIRM'S FINANCIAL POLICY AND INVESTMENT DECISIONS

The purpose of this thesis is, firstly, to model how multinational firms respond to the taxation of foreign direct investment income and, secondly, to measure the sensitivity of foreign direct investment to taxes.; Taxation of direct investment income is worth examining for at least two reasons. Firstly, direct investment has become increasingly significant in magnitude. Secondly, overlapping national tax claims to direct investment income give firms leeway to structure their operations to minimize global taxes or, indeed, to profit from conflicting tax systems.; The first part of the thesis models how various rules for taxing foreign source income affect a firm's foreign operation. Two features of the model are novel for this literature. Firstly, it is a multi-period model where the timing of taxes on foreign income matters. Firms can generally change the timing of taxes on foreign income by changing the timing of payments from their subsidiaries. Secondly, the subsidiary's financial policy is endogenous, albeit constrained, allowing the firm to use its financial policy to exploit overlapping tax systems. The model is simple but general in that two parameters can characterize any system for taxing foreign income.; The rest of the thesis concerns testing the tax sensitivity of U.S. direct investment abroad and foreign direct investment in the U.S. Firstly, some previous empirical studies are critically re-examined. Many previous results stem from problems in the data and equation specifications. Secondly, the influence of Canadian taxes on U.S. direct investment in Canada is examined using the neoclassical investment mode. Using the model developed earlier in the thesis and additional assumptions regarding financial policy, user costs of capital services for U.S. firms in Canada with detailed specifications of tax parameters are derived. Estimates of a variety of alternative investment equations yield consistent evidence of significant tax effects. Finally, the influence of U.S. taxes on U.S. direct investment in Canada is investigated using effective marginal tax rates for U.S. firms operating in the U.S. and in Canada. Consistent evidence is found that U.S. taxes affect U.S. direct investment in Canada.