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• Article | National Tax Journal | December, 2011

  Tax Policy and the Efficiency of U.S. Direct Investment Abroad

  Mihir A. Desai, C. Fritz Foley and James R. Hines Jr.

  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.

  Keywords: Policy; Taxation; Performance Efficiency; Foreign Direct Investment; Investment Funds; Investment Return; Business Earnings; Equity; Financing and Loans; Cash Flow; Capital; United States;

  Citation:

  Desai, Mihir A., C. Fritz Foley, and James R. Hines Jr. "Tax Policy and the Efficiency of U.S. Direct Investment Abroad." National Tax Journal 64 (December, 2011): 1055–1082.

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• Working Paper | 2012

  Trade Credit and Taxes

  Mihir Desai, C. Fritz Foley and James R. Hines Jr.

  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.

  Keywords: Trade; Capital; Taxation; Resource Allocation; Credit; Multinational Firms and Management; United States;

  Citation:

  Desai, Mihir, C. Fritz Foley, and James R. Hines Jr. "Trade Credit and Taxes." NBER Working Paper Series, No. 18107, May 2012.

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• Article | Harvard Business Review | March 2012

  The Incentive Bubble

  Mihir Desai

  The past three decades have seen American capitalism quietly transformed by a single, powerful idea—that financial markets are a suitable tool for measuring performance and structuring compensation. Stock instruments for managers, high-powered incentive contracts for investors, and the rise of alternative assets have dramatically altered the nature and level of incentives and rewards in our society, on both sides of the capital market. These changes have contributed significantly to the twin crises of modern American capitalism: repeated governance failures, which lead many to question the stewardship abilities of American managers and investors, and rising income inequality. When risk is repeatedly mispriced because investors enjoy skewed incentive schemes, financial capital is being misallocated. When managers undertake unwise investments or mergers in order to meet expectations that will trigger large compensation packages, real capital is being misallocated. And when relative compensation is as distorted as it has been by the financial-incentive bubble over the past several decades, one can only assume that human capital is being misallocated, to a disturbing degree. Awakening our monitors to their responsibilities and to the flaws of market-based compensation provides the best hope for correcting these imbalances and strengthening the U.S. economy for the challenges of this century.

  Keywords: Economic Systems; Financial Markets; Executive Compensation; Motivation and Incentives; Corporate Governance; Equality and Inequality; Human Capital; United States;

  Citation:

  Desai, Mihir. "The Incentive Bubble." Harvard Business Review 90, no. 3 (March 2012).

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