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We examine whether repatriation tax liabilities affect bond pricing using four settings: (1) pricing on a new bond issuance, (2) pricing changes around the American Jobs Creation Act of 2004 (AJCA), (3) pricing changes around the 2016 US election, and (4) pricing changes around the Tax Cuts and Jobs Act of 2017 (TCJA). The preponderance of evidence suggests that bondholders incorporate expected repatriation taxes into bond prices. However, this evidence appears concentrated around the 2004 AJCA (which created a repatriation tax holiday) and the 2016 US election (which unexpectedly increased the likelihood of a reduction in repatriation tax rates), arguably the strongest two experiments of the four. Around the 2016 US election, we find cross-sectional evidence suggesting that the positive relation between returns and repatriation tax liabilities is strongest for firms for firms that likely faced greater borrowing distortions due to repatriation taxes and for repatriation tax liabilities specifically on foreign cash. We do not find evidence that bondholders price repatriation tax liabilities on foreign earnings that have been reinvested in operating assets, suggesting that they do not price all repatriation tax liabilities equally. Overall, our results are consistent with lenders pricing when these liabilities are causing distortions in firms’ borrowing decisions and when they are more likely to be paid.

We identify an item recognized on the balance sheet that distorts the assessment of default risk. Firms enter into derivatives to protect themselves from price fluctuations on a future purchase or sale commitment denominated in a commodity, foreign currency, or interest rate. There are two reasons why the accounting for these transactions creates difficulty in default risk assessments. First, while the fair value of the derivative is recorded at each balance sheet date, the value of the forecasted purchase or sale commitment is not recorded. Therefore, the balance sheet only tells half of the economic story. Second, the gains/losses associated with these derivatives provide a signal about future firm profitability, which is a determinant of default risk. We examine the extent to which debt investors, credit analysts, and equity investors understand the implications of these transactions for a firm’s default risk. Our results suggest that all three of these groups remove derivative amounts from firms’ balance sheet ratios when assessing default risk. However, only debt investors correctly price the implications of future profitability on default risk. Overall, our results suggest that the accounting for cash flow hedges distorts a firm’s leverage and profitability ratios, that not all investors adjust for this, and that capital market participants might benefit from more transparent hedging disclosures, particularly related to profitability.

As the U.S. dollar (USD) strengthens relative to foreign currencies, the USD value of foreign subsidiary-to-parent dividends decreases, and the foreign tax credit remains anchored at a blended rate. During periods of USD strength, this asymmetry lowers the effective tax cost of repatriation at the cost of a lower after-tax dividend to the U.S. parent. This paper develops a firm-specific measure of currency exposure and provides evidence that repatriation likelihood increases during periods of firm-specific USD strength. We show that investors place a premium on repatriation costs when the USD strengthens against a firm-specific basket of currencies for repatriating firms. This premium implies that investors value the benefit of a lower effective tax cost of repatriation more than the potential cost of a lower after-tax dividend available to the U.S. parent. These results appear concentrated in firms with high levels of foreign cash and firms susceptible to earnings fixation.

The Tax Cuts and Jobs Act of 2017 (TCJA) reduces U.S. multinational companies’ (MNC) internal capital market frictions related to repatriation costs by decreasing costs to access internal capital (i.e., foreign cash). This study examines MNCs’ responses to the TCJA and finds spending and investment behavior are dependent upon liquidity, investment opportunities, and borrowing costs. Domestic capital expenditures increased for MNCs with low domestic liquidity and high domestic investment opportunities. These firms also increased share repurchases. In contrast, MNCs with low domestic liquidity and low domestic investment opportunities increased dividends. MNCs with low domestic investment opportunities and high cost of debt reduced their outstanding debt. We also investigate responses to global intangible low-taxed income (GILTI) incentives and find that MNCs with more foreign cash and a greater likelihood of being affected by the GILTI regime increase their foreign but not domestic capital expenditures - a potential unintended consequence of TCJA.

The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated disincentives for U.S. multinational corporations (MNCs) to repatriate foreign subsidiaries’ earnings, but the TCJA included additional provisions that will impact U.S. firms’ acquisition decisions. We find that both the likelihood and number of domestic and foreign acquisition announcements made by U.S. firms decreased on average after the TCJA but increased with repatriation taxes that U.S. MNCs faced prior to the TCJA. This effect is stronger for those MNCs that held larger amounts of foreign cash prior to the TCJA. The post-TCJA increase in foreign target acquisitions is driven by MNCs that are more likely to be subject to the global intangible low-tax income (GILTI) provisions after the TCJA. Our results suggest that the GILTI provisions introduced a contradictory incentive for U.S. MNCs with higher returns from intangible assets to investment in foreign target firms with lower returns on tangible property.

We identify an item recognized on the balance sheet that distorts the assessment of default risk. Firms enter into derivatives to protect themselves from price fluctuations on a future purchase or sale commitment denominated in a commodity, foreign currency, or interest rate. There are two reasons why the accounting for these transactions creates difficulty in default risk assessments. First, while the fair value of the derivative is recorded at each balance sheet date, the value of the forecasted purchase or sale commitment is not recorded. Therefore, the balance sheet only tells half of the economic story. Second, the gains/losses associated with these derivatives provide a signal about future firm profitability, which is a determinant of default risk. We examine the extent to which debt investors, credit analysts, and equity investors understand the implications of these transactions for a firm’s default risk. Our results suggest that all three of these groups remove derivative amounts from firms’ balance sheet ratios when assessing default risk. However, only debt investors correctly price the implications of future profitability on default risk. Overall, our results suggest that the accounting for cash flow hedges distorts a firm’s leverage and profitability ratios, that not all investors adjust for this, and that capital market participants might benefit from more transparent hedging disclosures, particularly related to profitability.

An unrealized gain on a cash flow hedge implies that the price of the underlying hedged item (i.e., commodity price, foreign currency exchange rate, or interest rate) moved in a direction that will negatively affect the firm’s profits after the hedge expires. Similarly, a loss implies that prices moved in a direction that will positively affect the firm’s profits after the hedge expires. Prior research shows that unrealized gains/losses on cash flow hedges are negatively associated with future earnings, and that investors’ expectations, as reflected in stock prices, do not appear to anticipate this association. We provide further evidence on this identified mispricing by examining whether sophisticated information intermediaries (i.e., financial analysts) understand the future earnings effects of cash flow hedges. We offer three main results. First, we find that analysts do not correctly incorporate unrealized cash flow hedging gains and losses into their earnings forecast for two- and three-year ahead earnings forecasts. Second, we find that analysts correct their errors after the cash flow hedges have largely expired (i.e., in about one year), and that investors correct their mispricing at this time. Finally, we find that when managers provide forecasts, analysts and investors are better able to process cash flow hedge information. Overall, our results suggest that the fair value accounting model for cash flow hedges combined with complex and incomplete firm disclosures results in investor mispricing, even for sophisticated investors, and that this mispricing can be mitigated if managers provide more transparent, complete, and forward-looking disclosures.