Repatriation Tax Costs and Managers’ Spending of Excess Cash

• In Event: Cash and Finance

Abstract

Prior research provides evidence that excess cash relates negatively to future performance. This result is often attributable to managers’ wasteful spending (i.e., agency costs). We are interested in one particular mechanism which potentially restricts managers’ ability to waste excess cash – repatriation costs. Repatriation costs represent additional U.S. taxes on foreign profits returned to the U.S. Managers often choose to avoid these additional taxes by keeping profits overseas, and that limits their cash available for domestic spending. We predict and find that repatriation costs reduces the negative relation between excess cash and future domestic performance (i.e., reduces wasteful spending). However, during the repatriation tax holiday of 2004 and 2005, the negative relation between excess cash and future domestic performance remains. These results are consistent with the tax holiday removing the governance mechanism of repatriation costs and leading to wasteful domestic spending. Finally, we examine the five-day cumulative abnormal returns surrounding domestic acquisition announcements. Consistent with the findings for future domestic performance, we find that the negative market reaction to domestic acquisition announcements for firms with excess cash is suppressed in the presence of repatriation costs. Overall, the evidence suggests that repatriation costs restrict managers’ financial flexibility, resulting in more efficient domestic spending for firms holding excess cash.

Authors

• Jimmy Downes, University of Nebraska-Lincoln

• Don R Herrmann, Oklahoma State University

• Wayne B. Thomas, University of Oklahoma