Tax Haven Incorporation and the Cost of Capital

Abstract

While incorporating the firm’s parent company in a tax haven offers tax savings, it also imposes risks. We predict and find a higher cost of equity capital in firms with parent companies that are incorporated in tax havens. We find that the observed cost of equity premium is enhanced by tax risk, firm-level information risk, and country-level legal risk. We also employ corporate inversions in a difference-in-differences test and again find a positive relation between tax haven parent incorporation and the cost of capital. Our study contributes to the literatures on valuation of tax haven use, tax and nontax costs of corporate strategies, corporate inversions, and the relation between taxes and the cost of capital.