Case | HBS Case Collection | 2004 (Revised from original 2004 version)

Innocents Abroad: Currencies and International Stock Returns

by Mihir A. Desai, Kathleen Luchs and Mark Veblen

Abstract

What do international stocks contribute to the portfolio of a U.S. investor? How do currencies interact with stock price movements in determining the benefits of international diversification? This case helps students compare the risks and returns of foreign stock markets with each other and with the U.S. market and to examine the risks and returns of international diversification. Students must calculate returns, adjust for currencies, derive correlations, and map efficient frontiers based on raw data. To obtain executable spreadsheets (courseware), please contact our customer service department at custserv@hbsp.harvard.edu.

Keywords: Stocks; International Finance; Currency; Investment Portfolio; Risk and Uncertainty; Investment Return; Diversification; Financial Markets; Financial Services Industry; United States;

Format: Print

21 pages

Purchase

Citation:

Desai, Mihir A., Kathleen Luchs, and Mark Veblen. "Innocents Abroad: Currencies and International Stock Returns." Harvard Business School Case 204-141, November 2004. (Revised from original March 2004 version.)

Deferral of U.S. taxes on foreign source income is commonly characterized as a subsidy to foreign investment, as reflected in its inclusion among "tax expenditures" and occasional calls for its repeal. This paper analyzes the extent to which tax deferral and other policies inefficiently subsidize U.S. direct investment abroad. Investments are dynamically inefficient if they consistently generate fewer returns to investors than they absorb in new investment funds. From 1982 to 2010, repatriated earnings from foreign affiliates exceeded net capital investments by $1.1 trillion in 2010 dollars; and from 1950 to 2010, repatriated earnings and net interest from foreign affiliates exceeded net equity investments and loans by $2.1 trillion in 2010 dollars. By either measure, cash flows received from abroad exceeded 160% of net investments, implying that foreign investment over these periods was dynamically efficient.

The article argues that U.S. taxation reform should reduce corporate taxes, incorporate an awareness of the global marketplace, and generate revenue-neutral incentives for innovation. According to the article, a reduction in corporate tax rates would be offset by a tax on noncorporate business income and an expansion of taxable income. Topics include tax-avoidance techniques, globalization, repatriation taxes, corporate social responsibility, and U.S. workers. Graphs are included, which compare the U.S. tax rate with other countries.

This paper analyzes the extent to which firms use trade credit to reallocate capital in response to tax incentives. Tax-induced differences in pretax returns encourage the use of trade credit to reallocate capital from firms facing low tax rates to those facing high tax rates. Evidence from the worldwide operations of U.S. multinational firms indicates that affiliates in low-tax jurisdictions use trade credit to lend, whereas those in high-tax jurisdictions use trade credit to borrow: 10% lower local tax rates are associated with net trade credit positions that are 1.4% higher as a fraction of sales. The use of trade credit to get capital out of low-tax, low-return environments is also illustrated by reactions of U.S. firms to the temporary repatriation tax holiday in 2005, when affiliates with positive net trade credit positions were significantly more likely than others to repatriate dividends to parent companies in the United States.

General Information

Academic Programs

Alumni

Faculty & Research

Recruit

Resources

Faculty & Research

Innocents Abroad: Currencies and International Stock Returns

Abstract

About the Author

More from the Author

Contact

Related Links

Resources