Here is a paper by Harry Huizinga, Johannes Voget and Wolf Wagner studying the relationship between capital gains taxation and cross-border takeover premia:
Whether capital gains tax has a significant effect on investment expenditure has been a matter of significant research. The logic adopted by Huizinga, Voget and Wagner is that capital gains tax would affect investment expenditure if it reduces the price of equity in the stock markets, thus reducing the money that can be raised by companies by selling equity. Since any researcher would need a range of capital gains tax rates to be able to study its effect, the only logical way to do it is to study it across countries. The authors choose to study the premiums associated with cross-border takeovers.
A differentiation is made between the long term capital gains tax rate (t) and the short term capital gains tax rate (s).The authors start out with three hypothesis for cash-financed transactions, which are as follows:
- a higher difference between acquirer and target country long term rates leads to lower premium
- a higher difference between short term and long term rate in target country leads to higher premium
- an increase in long term rate in target country leads to higher premium
The second major direction of the paper is the probability of a cash-financed versus equity-financed takeover. For this, the authors hypothesize that the propensity to use cash financing decreases with:
- difference between the acquirer and target country long term rates
- difference between short and long term rate of target country
- long term rate of target country
The testing of these hypotheses is done in two stages - in the first stage, the sample is divided into a few sets based on the values of the three listed variables, and then summary statistics are calculated for the different sets to see if they different significantly; in the second stage, the authors construct a series of regression models, adding corporate income tax rates and institutional environment in more complex models. The coefficients in these regressions then indicate if the particular factor is significant or not.
What I particularly like about this paper is the authors' willingness to take the reader through the process of coming up with a robust model. For example, the problem of multicollinearity is detected early on between the last two variables listed above, and then a way is found to circumvent this problem.
The results of this paper are fairly straightforward, and hence the first thought I had after reading the paper was what the implication would be for takeovers involving India. With that spirit, the key insights for me from this paper were:
- In all models except equity-financed takeovers, the coefficient for the cross-country long term tax difference is significant at the 5% level of significance. I read that there is no long term capital gains tax in India; which would imply that Indian companies acquiring targets abroad will be able to pay higher premia. Could it then be that that the absence of a long term capital gains tax in India acts as a spur to cash-financed takeovers abroad? From the second set of hypotheses, this would imply that most takeovers by Indian companies should be cash-financed.
- In most models, the difference between the short and long term capital gains tax rate in the target country is statistically significant. For India, this would mean that foreign companies aiming to take over target companies in India would have to pay high premia. This would act as a potential deterrent to cash-financed deals. From the second set of hypotheses, this would imply that most takeovers of Indian companies should be debt-financed.
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