Working Paper: CEPR ID: DP14636
Authors: Laura Alfaro; Ester Faia; Ruth Judson; Tim Schmidteisenlohr
Abstract: A confidential dataset with industry-level disaggregation of U.S. cross-border claims and liabilities, shows U.S. securities to be increasingly intermediated by tax-haven- financial-centers (THFC) and less regulated funds. These securities are risky, in intangible-intensive sectors, requiring higher Sharpe ratios; while the foreign-official sector mainly holds Treasuries. Facts on private securities are rationalized through a model where firms with heterogeneous default probabilities, and funded by global intermediaries, endogenously locate affiliates in THFCs. A decline in the cost of funds or in THFC’s taxes/regulation, raises profits and firms’ incentives to enter THFCs. Firms appear elusively safe, intermediaries reduce monitoring incentives and debt risk increases.
Keywords: tax havens; financial centers; tax avoidance; regulatory arbitrage; risk; uncertainty; heterogeneous firms; endogenous entry; endogenous monitoring
JEL Codes: F2; F4; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decline in the cost of funds or in tax/regulation in tax haven financial centers (THFC) (F38) | Increase in profits and firms' incentives to enter THFC (L19) |
| Riskier firms with heterogeneous default probabilities (G33) | More likely to seek funding from global intermediaries in THFC (F65) |
| Firms entering THFC (L19) | Decrease in monitoring incentives for intermediaries (G18) |
| Decrease in monitoring incentives for intermediaries (G18) | Increase in debt risk (F34) |
| Flows toward THFC (E50) | Correlate positively with risk metrics (higher realized volatility and lower monitoring intensity) (C58) |
| Reduction in taxes or regulation in THFC (H29) | Encourages riskier firms to enter (G24) |
| Interaction of lower taxes and increased global liquidity (F69) | Incentivize riskier firms to enter THFC (G29) |
| Riskier firms entering THFC (G29) | Increase in average risk of US debt liabilities (H69) |