Governments around the world frequently adjust corporate tax rates, expecting businesses to respond by changing how they invest, borrow, and grow. The underlying assumption is simple: lower taxes should encourage firms to take on more debt, invest more aggressively, and expand operations. However, new research suggests that this assumption may overlook a critical factor. Not all companies respond to tax changes in the same way.
A recent study by Paolo Panteghini, conducted at the University of Brescia, co-authored by Raffaele Miniaci, and published in the journal German Economic Review, challenges traditional views on corporate finance by showing that the impact of taxation on firms’ capital structure is far from uniform. The paper, titled “On the Capital Structure of Foreign Subsidiaries: Evidence from Panel Data Quantile Regression Models”, provides insights into how multinational subsidiaries adjust their borrowing behaviour in response to taxation and profitability.
Rethinking how companies finance themselves
At the heart of corporate finance lies a fundamental question: how do firms choose between debt and equity? This decision, often referred to as a company’s capital structure, has long been explained by two dominant theories.
The Pecking Order Theory suggests that firms prefer internal financing, such as retained earnings, before turning to external financing, such as debt or equity. According to this view, more profitable firms borrow less because they rely on their own resources. In contrast, the Trade-Off Theory argues that firms balance the tax advantages of debt with the risks of financial distress. Since interest payments are often tax-deductible, borrowing can reduce a company’s tax burden.
While both theories offer valuable insights, they were largely developed with domestic firms in mind. In today’s globalised economy, many companies operate across borders through foreign subsidiaries, making their financial decisions more complex. Differences in tax regimes across countries create opportunities for multinational corporations to allocate debt within their corporate structures strategically.
A large-scale study of multinational subsidiaries
To better understand these dynamics, the researchers analysed a dataset of more than 70,000 foreign subsidiaries operating across 29 European countries. The data, sourced from the Orbis database, covered the period from 2009 to 2017 and included detailed information on firms’ financial statements, ownership structures, and tax environments.
What sets this study apart is its methodological approach. Instead of relying on standard linear regression models that estimate average effects, the authors employed panel-data quantile regression to examine how taxation and profitability affect firms at different points along the leverage distribution. More specifically, they estimated unconditional quantile partial effects, thereby capturing how changes in tax rates affect not only the average firm but also firms with low, medium, and high levels of indebtedness.
This approach addresses a key limitation in previous research. Traditional models often mask heterogeneity by focusing on average outcomes, potentially overlooking important differences across firms.
Taxes matter, but not for everyone
One of the most important findings of the study is that the effect of corporate taxation on leverage is highly heterogeneous. Subsidiary-level tax rates were found to positively affect leverage, particularly among firms in the lower deciles of the leverage distribution. In simpler terms, companies with relatively low debt levels are more likely to increase borrowing when tax rates rise, as they seek to benefit from the tax deductibility of interest payments.
However, this effect diminishes significantly for firms with higher debt levels. Highly leveraged companies appear less responsive to tax incentives, likely because they face constraints such as increased risk of financial distress or limited access to additional credit. This suggests that the traditional assumption that tax incentives uniformly encourage borrowing does not hold in practice.
The study also finds that parent company tax rates are inversely related to subsidiary leverage, particularly for firms with low debt levels. This reflects the strategic allocation of debt within multinational groups, where companies may shift borrowing across jurisdictions to minimise their overall tax burden.
Profitability tells a different story
In contrast to the mixed effects of taxation, profitability exhibits a consistent relationship with leverage across the entire distribution. The analysis shows that more profitable firms tend to borrow less, supporting the Pecking Order Theory’s predictions.
This finding reinforces a well-established empirical pattern in corporate finance. Firms with strong internal cash flows are less reliant on external financing and therefore maintain lower debt levels. Importantly, the negative relationship between profitability and leverage holds across all quantiles, suggesting that this behaviour is robust regardless of a firm’s existing level of indebtedness.
The results also highlight the importance of other firm-specific characteristics, such as asset structure, liquidity, and size. These factors influence capital structure decisions in different ways depending on where a firm sits within the leverage distribution, further underscoring the complexity of corporate financial behaviour.
Why average effects can be misleading
A key contribution of the study lies in its demonstration that average marginal effects can obscure important variations across firms. By focusing on the mean, traditional models may give the impression that tax policy has a uniform impact, when in reality the effects are concentrated among specific groups of companies.
The use of unconditional quantile regression enables policymakers and researchers to examine how tax changes affect the entire distribution of corporate leverage. This provides a more nuanced understanding of policy effectiveness and underscores the need to account for firm heterogeneity when designing tax interventions.
For example, a tax reform aimed at encouraging investment through increased borrowing may primarily affect firms with low initial debt levels, while having little impact on highly leveraged firms. Without accounting for this variation, policymakers risk overestimating the effectiveness of such measures.
Implications for tax policy and economic strategy
The findings of this research carry significant implications for corporate tax policy, particularly for multinational enterprises. As governments seek to attract investment and stimulate economic growth, understanding how firms respond to tax incentives becomes increasingly important.
The evidence suggests that a one-size-fits-all approach to taxation may be insufficient. Instead, targeted policies that account for differences in firms’ financial positions could prove more effective. For instance, measures designed to support highly leveraged firms may need to address constraints beyond taxation, such as access to credit or financial stability concerns.
Moreover, the study highlights the role of international tax differentials in shaping corporate behaviour. Multinational companies are able to exploit variations in tax rates across jurisdictions, shifting debt and profits in ways that minimise their overall tax liability. This raises broader questions about tax competition and the coordination of fiscal policies across countries.
The bigger picture
In an increasingly interconnected global economy, the financial decisions of multinational corporations play a crucial role in shaping economic outcomes. This study offers a timely reminder that a complex interplay of factors, including taxation, profitability, and firm-specific characteristics, influences these decisions.
As debates over corporate taxation continue, particularly amid global minimum tax initiatives and efforts to curb profit shifting, insights from studies like this one will be essential. Understanding not just whether taxes matter, but how and for whom they matter, is critical for shaping the future of economic policy.
Reference
Miniaci, R., & Panteghini, P. M. (2025). On the capital structure of foreign subsidiaries: Evidence from panel data quantile regression models. German Economic Review. https://doi.org/10.1515/ger-2024-0123
