Introduction Tax Avoidance Methodology Results Conclusion

Tax Avoidance as a driver of Mergers & Acquisitions?

Thomas Belz, Christian SteffensUniversität Mannheim

Leslie RobinsonTuck School of Business at Dartmouth

Martin RufUniversität Tübingen

Oxford 27.6.2014

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Introduction Tax Avoidance Methodology Results Conclusion

Introduction

I The acquirer of a firm is able to run the firm better than the initialowner (ownership advantage).

I Due to the higher expected cash flow the acquirer is able to outbidthe reservation price of the initial owner.

I There are many possible reasons for ownership advantages - onecandidate is taxation.

I Firms on average pay 30 % of their profits to the state as taxes.

I Is an acquirer able to reduce this percentage, this results in anownership advantage.

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Introduction Tax Avoidance Methodology Results Conclusion

Introduction

I Acquirers do not actively search for badly tax managed targets.

I But acquirers should predict future cash flows taking taxation intoaccount.

I When predicting future tax payments they should rely on their pastexperience and take their typically applied tax avoidance strategiesinto account.

I Firms differ with respect to their tax avoidance activities.

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Introduction Tax Avoidance Methodology Results Conclusion

Introduction

I Is tax avoidance a driver of mergers & acquisitions?

I Do we observe increased tax avoidance activities after mergers &acquisitions?

I European mergers & acquisitions from 1998 to 2009.

I Is tax avoidance important for initial owners to prevent takeovers?

I Are small and medium sized firms forced to sell to internationalacquirers due to systematic disadvantages with respect to their taxavoidance possibilities?

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Introduction Tax Avoidance Methodology Results Conclusion

Cash ETR

I Tax avoidance in 3 dimensions: cash ETR, leverage, transfer pricing.

I First dimension: Cash ETR (taxes paid/financial profits).

I The first driver of the cash ETR is the statutory tax rate.

I The second driver is the difference between financial accounting andtax accounting.

I The cash ETR is thus a measure for the tax accounting policy.

I Do we observe a decrease in the cash ETR after mergers &acquisitions?

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Introduction Tax Avoidance Methodology Results Conclusion

Cash ETR

I The cash ETR does not cover the two most important tax planningstrategies: Debt shifting and transfer pricing.

I Debt shifting and transfer pricing affect taxes paid and financialprofits. As a result the cash ETR should not change.

I Second dimension of tax avoidance: Debt shifting.I Interest expenses are tax deductible, while dividends are not =>

incentive to use debt at the firm level.I In a national setting interest earnings bear a higher tax load then

dividends => In sum in a national setting no/low incentive to use debtshifting.

I On the contrary in an international setting it is possible to useinternational tax differences to achieve a low taxation of interestearnings => Debt shifting is attractive.

I Do we observe a larger increase in leverage after internationalmergers & acquisitions?

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Introduction Tax Avoidance Methodology Results Conclusion

Debt shifting

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Introduction Tax Avoidance Methodology Results Conclusion

Transfer Pricing

I Third dimension of tax avoidance: Transfer pricing.

I Using transfer pricing it is possible to shift profits out of high taxcountries in low tax countries

I Only possible in multinational groups.

I Do we observe a larger reduction in a target’s profitability afterinternational mergers & acquisitions?

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Introduction Tax Avoidance Methodology Results Conclusion

Transfer Pricing

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Introduction Tax Avoidance Methodology Results Conclusion

Policy Concern

I Two dimensions of tax avoidance are only available to multinationalgroups: debt shifting and transfer pricing.

I National firms can not use these. They pay per se higher taxes thanan international acquirer would do.

I Does this tax disadvantage result in national firms being especialattractive targets?

I If so, this could be an economic justification for anti-abuse rules.

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Introduction Tax Avoidance Methodology Results Conclusion

Data

I M&A-Data base Zephyr and financial statements data AmadeusBureau von Dijk.

I 81.730 deals from 1998 to 2009.

I No consolidation of acquired firm following acquisition.

I We need financial statements for at least 7 consecutive years: 3years pre deal and 3 years post deal.

I Only corporations.

I Results in 832 deals.

I International vs. national takeovers.

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Introduction Tax Avoidance Methodology Results Conclusion

Data

I National vs. international Takeovers:I Use information on the group structure of the vendor and the

acquirer from Amadeus => 4 cases:1 International vendor - international acquirer or national - national: no

change in tax planning incentives (national takeover).2 National vendor - national acquirer: same.3 International vendor - national acquirer: decreased tax planning

incentives4 National vendor - international acquirer: increased tax planning

incentives (international takeover)

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Introduction Tax Avoidance Methodology Results Conclusion

Data

I Any step up in the financial statement of the target because of theacquisition may bias our results.

I We thus focus on share deals only: 100 % acquisition of shares ofcorporations.

I In the case of share deals not step up at the level of the acquiredcorporation in Europe possible (different in the US: Section 338election).

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Introduction Tax Avoidance Methodology Results Conclusion

Regional Origin of Acquirers

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Introduction Tax Avoidance Methodology Results Conclusion

Example

I Ergon NV, Belgium.

I Produces cement for construction industry.

I Sales 2003: 46 Mio EUR

I 2004: Acquired by CRH PLC, Ireland (Sales 2003: >11 Bio. EUR)

I CRH PLC is in the same industry.

Year 2002 2003 2005 2006Leverage 0.698 0.7 0.89 0.88Profitability 0.077 0.098 0.035 0.040

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Introduction Tax Avoidance Methodology Results Conclusion

Descriptives

I cash ETR (Acquisition: 0)

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Introduction Tax Avoidance Methodology Results Conclusion

Methodology

I Intuitive Research tool: Descriptive Statistic for cash ETR.

I Causality? Does this change occur because of acquisition or would ithave occurred anyway?

I How would the acquired firm have behaved without the acquisition?

I Basic problem of social sciences: We do not have laboratoryconditions - we can not observe the same firm twice.

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Introduction Tax Avoidance Methodology Results Conclusion

Methodology

I Propensity Score Matching: Attempt to approximate such laboratoryconditions.

I For each target find a very similar non acquired firm.

I Estimate the likelihood of being acquired for each firm (Selectionequation)

I Match each target with a non-acquired firm having a similarprobability for being acquired.

I Comparison of these firms allows to isolate the effect of theacquisition.

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Introduction Tax Avoidance Methodology Results Conclusion

Selection Equation

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Introduction Tax Avoidance Methodology Results Conclusion

Balancing Property

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Introduction Tax Avoidance Methodology Results Conclusion

Cash ETR

I Cash ETR Targets vs. non-Targets

Matching-Algorithm All International NationalRadius -0.0313 *** -0.0425 *** -0.0227 **

(-4.51) (-4.21) (-2.39)Kernel -0.0375 *** -0.0538 *** -0.0367 ***

(-5.42) (-5.33) (-3.87)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Cash ETR

I ETR: Tax aggressive vs. non tax aggressive acquirers

Matching algorithm Tax aggressive acquirer Non tax aggressive acquirerRadius -0.070 *** -0.03

(-3.54) (-1.57)Kernel -0.095 *** -0.059 ***

(-4.81) (-3.04)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Profitability

I Profitability Targets vs. Non-Targets

Matching-Algorithm All International NationalRadius -0.019 *** -0.0184 * -0.0212 ***

(-3.33) (-1.88) (-3.03)Kernel -0.0183 *** -0.0159 -0.0178 **

(-3.13) (-1.62) (-2.55)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Profitability

I Profitability: High tax Targets vs. low tax Targets

Matching algorithm High tax Low taxRadius -0.0359 *** -0.0083

(-2.66) (-0.65)Kernel -0.0334 ** -0.0058

(-2.47) (-0.46)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Leverage

I Leverage Targets vs. Non-Targets

Matching-Algorithm All International NationalRadius 0.020 * 0.004 0.032 **

(1.71) (0.21) (2.06)Kernel 0.014 -0.006 0.016

(1.21) (-0.34) (1.03)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Leverage

I Leverage: High tax Targets vs. low tax Targets

Matching algorithm High tax Low taxRadius 0.0117 -0.0018

(0.50) (-0.08)Kernel -0.0008 -0.0093

(-0.03) (-0.42)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Debt-Push-Down

I Group taxation could be a possible explanation for finding noleverage effect

I It is tax efficient to install debt finance at the level of holdings:Debt-Push-Down

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Introduction Tax Avoidance Methodology Results Conclusion

Leverage

I Leverage Targets vs. Non-Targets - no group taxation only

Matching-Algorithm AllRadius 0.083 ***

(3.26)Kernel 0.078 ***

(3.06)Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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Introduction Tax Avoidance Methodology Results Conclusion

Robustness

I Robustness check: Exact MatchingI CountriesI IndustryI Country-year

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Introduction Tax Avoidance Methodology Results Conclusion

Exact Matching

Matching algorithm All International National

Country specificAverage ETR All International NationalRadius -0.0334 *** -0.0453 *** -0.0241 *

(-3.41) (-3.13) (-1.82)Average Profitability All International NationalRadius -0.0201 ** -0.018 -0.02 **

(-2.54) (-1.47) (-1.99)Average Leverage All International NationalRadius 0.0224 0.002 0.0362 *

(1.42) (0.09) (1.70)Industry specific

Average ETR All International NationalRadius -0.0302 *** -0.042 *** -0.021 *

(-3.11) (-2.92) (-1.64)Average Profitability All International NationalRadius -0.0189 ** -0.018 -0.0196 **

(-2.42) (-1.44) (-1.97)Average Leverage All International NationalRadius 0.0211 0.0003 0.0316

(1.35) (0.17) (1.49)The symbols ***, **, and * denote significance at the 0.01, 0.05, and 0.10 levels, respectively.30

Introduction Tax Avoidance Methodology Results Conclusion

Conclusion

I The tax avoidance activities of targets increase after takeovers.

I This holds for the cash ETR and for transfer pricing (givenappropriate tax incentives).

I Debt shifting instead may take place at the level of acquiringholdings.

I The increased tax avoidance activities generate an ownershipadvantage.

I Mergers & acquisitions could be tax motivated.

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Introduction Tax Avoidance Methodology Results Conclusion

Conclusion

I Tax avoidance may help to avoid hostile take overs.

I So far the literature is concerned about the negative investmenteffects of anti abuse rules. However, they may help to prevent taxmotivated takeovers of national firms by multinational groups.

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Introduction Tax Avoidance Methodology Results Conclusion

Conclusion

I Thanks for your attention!

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Introduction Tax Avoidance Methodology Results Conclusion

Literature

I Blouin, Collins und Shackelford (2005, JATA) investigate the changein taxable income of US-firms following mergers & acquisitions.

I A large number of papers investigates the change in profitabilityfollowing mergers & acquisitions - only a few focus on the target(Martynova und Renneborg (2008, JBF)).

I Tax planning literature (cash ETR, debt shifting, transfer pricing:Chen et al. (2010, JFE), Desai et al. (2004, JoF), Huizinga undLaeven (2008, JPubE)). External shock acquisition to identify effects.

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Introduction Tax Avoidance Methodology Results Conclusion

Descriptives

I Profitability (Acquisition: 0)

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Introduction Tax Avoidance Methodology Results Conclusion

Descriptives

I Leverage (Acquisition: 0)

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Introduction Tax Avoidance Methodology Results Conclusion

Matching

I Y1i ist das Ergebnis für die Einheit i mit Treatment (hierUnternehmensübernahme), Y0i ist das Ergebnis für die Einheit iohne Treatment.

I Di ist Dummy für Treatment (dann Di = 1).

I Von Interesse: E[Y1i −Y0i |Di = 1].

I E[Y1i −Y0i |Di = 1] = E[Yi |Di = 1]−E[Yi |Di = 0]−{E[Y0i |Di =1]−E[Y0i |Di = 0]}

I Annahme {Y1i ,Y0i}⊥Di |Xi

I Dann gilt

E[Y1i −Y0i |Di = 1] = E{E[Y1i −Y0i |Xi ,Di = 1]|Di = 1}== E{E[Y1i |Xi ,Di = 1]|Di = 1]−E[Y0i |Xi ,Di = 1]|Di = 1]}

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Introduction Tax Avoidance Methodology Results Conclusion

Matching

I Wegen der Annahme gilt E[Y0i |Xi ,Di = 0] = E[Y0i |Xi ,Di = 1].

I und dann

E{E[Y1i |Xi ,Di = 1]|Di = 1]−E[Y0i |Xi ,Di = 0]|Di = 1]}== E[δX |Di = 1]

I mit δX ≡ E[Yi |Xi ,Di = 1]−E[Yi |Xi ,Di = 0]

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Introduction Tax Avoidance Methodology Results Conclusion

Hightax vs. Lowtax

I cash ETR Targets vs. Non-Targets (NN-Matching)

High-Tax Low-TaxETR -0.318*** -0.003Leverage 0.028 -0.02Profitability -0.001 -0.02Note: t-Values in parentheses.*** 1% level; **5% level;* 10% level.

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