Market Reactons to Export Subsdes Mhr A. Desa Harvard Unversty and NBER James R. Hnes Jr. Unversty of Mchgan and NBER December 2003 The authors are grateful to Naom Feldman for excellent research assstance and Davd Wensten for expert data gudance; to them and to semnar partcpants for helpful comments on earler drafts; and to the Los and Bruce Zenkel Research Fund at the Unversty of Mchgan and the Dvson of Research at Harvard Busness School for fnancal support.
Market Reactons to Export Subsdes ABSTRACT Ths paper analyzes the economc mpact of export subsdes by nvestgatng stock prce reactons to a crtcal event n 1997. On November 18, 1997, the European Unon announced ts ntenton to fle a complant before the World Trade Organzaton (WTO), argung that the Unted States provded Amercan exporters llegal subsdes by permttng them to use Foregn Sales Corporatons to exempt a fracton of export profts from taxaton. Share prces of Amercan exporters fell sharply on ths news, and ts mplcaton that the WTO mght force the Unted States to elmnate the subsdy. The share prce declnes were largest for exporters whose tax stuatons made the threatened export subsdy partcularly valuable. Share prces of exporters wth hgh proft margns also declned markedly on November 18, 1997, suggestng that the export subsdes were most valuable to frms earnng market rents. Ths last evdence s consstent wth strategc trade models n whch export subsdes mprove the compettve postons of frms n mperfectly compettve markets. JEL Classfcaton: F12, F13, H87, H25, D43. Mhr A. Desa James R. Hnes Jr. Harvard Busness School Offce of Tax Polcy Research Morgan 363 Unversty of Mchgan Busness School Solders Feld 701 Tappan Street Boston, MA 02163 Ann Arbor, MI 48109-1234 mdesa@hbs.edu jrhnes@umch.edu
1. Introducton Internatonal trade polces affect the welfare of natons and the proftablty of exporters. Classc trade models mply that countres beneft from free trade, whereas more recent strategc theores dentfy condtons n whch nterventonst polces such as export subsdes can mprove domestc welfare. There has been consderable theoretcal development of strategc trade theores wth only modest accompanyng emprcal support for underlyng assumptons and predctons. Ths paper offers evdence of the mpact of a strategc trade polcy by consderng market reactons to a surprse challenge to an export subsdy embedded n the U.S. corporate ncome tax. Ths event dentfes stock market valuatons of tax-based export subsdes, and the degree to whch they are affected by export propenstes, frm-specfc tax consderatons, and market structure. On November 18, 1997, the European Unon declared ts ntenton to brng a complant before the World Trade Organzaton (WTO), accusng the Unted States of volatng the rules prohbtng WTO members from subsdzng exports. Europe mantaned that the ablty of Amercan frms to route ther export sales through tax-avodance devces known as Foregn Sales Corporatons (FSCs) provded them wth export-contngent tax subsdes of roughly $4 bllon a year. The European Unon argued that European frms were thereby unfarly advantaged n competton wth Amercan frms n foregn markets, and requested that the WTO requre the Unted States to contnue ts export subsdy or else face sanctons and penaltes. Negotatons between the Unted States and Europe proved frutless, and the WTO n due course ruled aganst the Unted States twce, as a result of whch the export subsdes are n the process of beng elmnated. 1 Ths paper nvestgates the extent to whch share prces of Amercan exporters captalzed the threatened removal of export subsdes. For asset prce reactons to convey such nformaton, 1 In February 2000 the WTO ruled that the FSC program represented an llegal export subsdy. In November 2000 the Unted States passed legslaton elmnatng FSCs, but smultaneously ntroducng a new tax exempton for extraterrtoral ncome that has almost exactly the same export-subsdy effect as the former FSCs. Europe balked at ths purely formal change, challengng the revsed U.S. provsons before the WTO; the WTO n January 2002 agan found the Unted States to be n volaton of ts rules, and n August 2002 authorzed the European Unon to mpose up to $4 bllon a year of retalatory tarffs on the Unted States. In an effort to lmt the economc damage from ths and other trade putes, Presdent Bush and Congressonal leaders have declared ther ntenton to remove the export subsdes ntroduced n 2000, and not to replace them; such legslaton s currently pendng before Congress.
t s necessary that market partcpants consdered the European challenge to be an unantcpated and sgnfcant development. U.S. news accounts on November 18, 1997 offered extensve coverage of the detals and (large) magntude of the subsdy; journalsts descrbed Amercan offcals as stunned; and the chef of staff of the U.S. Congress Jont Tax Commttee later publcly commented, frankly, we ve been somewhat surprsed by ths development. 2 Consequently, share prce movements on the day of the European announcement should embody market valuatons of expected losses from possble future repeal of the export subsdy. The evdence ndcates that shares prces of Amercan frms whose sales were domnated by exports fell sharply on November 18, 1997. These prce movements were greatly attenuated for exporters wth net operatng loss carryforwar, for whom tax subsdes are less valuable than they are for others. Smlarly, the stock prces of frms wth foregn ncome taxed at hgh rates reacted less sharply than dd other stock prces, reflectng the exstence of a generous alternatve export subsdy avalable only to frms wth heavly taxed foregn ncome. It s tellng that share prces of Japanese frms, who were not drectly affected by the events of November 18, 1997, exhbted none of the same prce movement patterns as Amercan frms, suggestng that the Amercan share prce reactons reflect consderatons that are specfc to U.S. taxpayers. It s possble for export subsdes to mprove the compettve postons of frms n mperfectly compettve markets by commttng them to hgh levels of producton for export markets, couragng some of the competton that mght otherwse come from foregn rvals. The strategc trade models developed by Brander and Spencer (1985), Eaton and Grossman (1986, 1988), and others, and revewed n Brander (1995), take ths observaton as ther pont of departure. Subsequent developments n ths lterature explore the mpact of dfferng specfcatons of olgopolstc nteracton, 3 the nformatonal and commtment requrements of 2 For journalstc accounts of the reacton from whch these quotes are drawn, see Gordon Platt, U.S. To Fght For Foregn Sales Corporatons, Journal of Commerce, December 2, 1997 and Judth Burns, Treasury s Lubck Says Can t Rule Out Acton Vs. EU, Dow Jones News Servce, December 12, 1997. 3 See, for example, Eaton and Grossman (1986, 1988), Magg (1996), Bagwell and Stager (1997, 2001), Leahy and Neary (2001), Zhou, Spencer, and Vertnsky (2002), and Kohler and Moore (2003). 2
effectve export promoton through subsdes, 4 and the mpact of export subsdes when product qualty s dffcult to verfy. 5 Krugman (1993), Feenstra (1995) and others note that there s lttle n the way of systematc emprcal nvestgaton of the extent of competton n export markets and, therefore, the scope for ncome-enhancng strategc trade polces. 6 Krugman (1993) observes that efforts to quantfy the gans from rent-snatchng suggest small payoffs and Magg (1996) ad that the jury s stll out for the emprcal evaluaton of trade polces. A notable excepton s Berry, Levnsohn and Pakes s (1999) study of voluntary export restrants n the automoble ndustry. Share prce reactons to the removal of export subsdes offer evdence of market perceptons, snce the value of such subsdes should vary systematcally wth the degree of export market competton. The evdence ndcates that the share prces of more proftable frms exhbted the most sharply negatve reactons to news of the European complant, whch s consstent wth the mplcatons of models of export subsdes n mperfectly compettve ndustres and wth aspects of strategc trade theory. Secton two of the paper consders a smple model of the ncdence of export subsdes embedded n the corporate ncome tax under varyng market structures, drawng predctons for the mpact of the WTO controversy on share prces. Secton three descrbes the two prmary tax subsdes avalable to Amercan exporters and ther nteracton. Secton four examnes the determnants of abnormal returns for Amercan exporters on November 18, 1997, fndng that the WTO event s assocated wth stock prce movements that match tax characterstcs and n whch more proftable frms are the most severely mpacted. Secton fve concludes wth observatons about the poltcal economy of provdng export subsdes through the ncome tax. 2. The Incdence of Export Subsdes Under Imperfect Competton In order to assess the determnants of share prce reactons to the WTO complant, t s useful to consder a model of exporter behavor under varyng market structures. Ths secton 4 As n Qu (1994, 1995), Goldberg (1995), Branard and Martmort (1996, 1997), Magg (1999), and Leahy and Neary (1999, 2000). 5 See Bagwell (1991). 6 More recently, Antweler and Trefler (2002) offer evdence ndcatng that nternatonal trade patterns are consstent wth producton processes exhbtng scale economes that may support olgopolstc outcomes. 3
develops a partal equlbrum model that captures many of the features of the FSC regme partcularly that subsdes are functons of profts n order to solate the most mportant determnants of estmated prce reactons, ncludng the effect of market structure and the market share of Amercan exporters. Consder the case of an Amercan frm actng as a Cournot compettor n an nternatonal ndustry wth a fxed number (N) of equal-szed frms producng homogenous products. In order to smplfy the analyss, frms are assumed to produce wth constant return to scale technology usng fxed captal (k) and labor (l) nputs per unt of output. The U.S. government subsdzes export ncome at rate s, so frm s economc proft ( π ) s gven by: π = p wl 1 + s x ρkx, (1) ( )( ) n whch p s the market prce of the frm s output, x the quantty t produces, and w the wage rate. For smplcty, captal s assumed not to deprecate, and to be fnanced entrely wth equty, the opportunty cost of whch s denoted ρ. Snce ncome s defned for U.S. tax purposes wthout a deducton for the opportunty cost of equty captal, the export subsdy apples to accountng profts that do not correspond to the economc profts that the frm maxmzes. In ths partal-equlbrum settng, t s approprate to take p to be a functon of ndustry output, denoted X. The frm s frst-order condton characterzng the proft-maxmzng output level s dp dx (2) p + x ( 1+ ) ρk θ = wl +, ( 1+ s) dx n whch θ s frm 's conjectural varaton, correspondng to 1. Dfferng market dx structures correspond to dfferng values of θ. In a Cournot-Nash settng, n whch frm beleves that ts quantty decsons do not affect the quanttes produced by ts compettors, then θ = 0. In a perfectly compettve settng, θ = 1. Varous Stackelberg possbltes correspond to values of θ that dffer from these, and ndeed, need not le n the [-1, 0] nterval. 4
It s useful to consder the prcng mplcatons of (2). In dong so, t s necessary to take nto account that foregn frms n the ndustry are nelgble for the Amercan export subsdy (unless they produce n the Unted States for export). Let n denote the number of Amercan exporters n the ndustry, and (N n) the number of ther foregn compettors. Furthermore, n order to smplfy the calculatons that follow, we consder the case n whch the consumer 2 p demand functon s locally lnear, so that = 0. 7 For an Amercan frm, dfferentatng both 2 X sdes of (2) wth respect to s produces the followng comparatve statc: dp dx dx dx (3) + ( 1+ ) ρk θ =. ( 1+ s) 2 By contrast, the behavor of foregn frms who are nelgble for export subsdes, but otherwse (by assumpton) dentcal to ther Amercan compettors s determned by (ndexng foregn frms wth j): dp dx dx dx + θ j (4) ( 1 + ) = 0 In order to assess the ncdence of the subsdy, t s useful to consder the responsveness of the market prce to changes n the subsdy as gven by the dentty. dp dp dx dx. Snce the market contans (N-n) foregn frms and n domestc frms, the relatonshp between market output and the subsdy s gven by, dx (5) = ( N n) dx j dx + n Equaton (4) mples that, for foregn frm j and demand curves that are less than nfntely elastc, dx j (6) = ( 1+θ ) dx. 7 See Auerbach and Hnes (2003) for an analyss of more general cases n whch demand curves are not locally 5
As dx j dx s gven by (6), and s gven by (3), (5) becomes (7) dx ( 1 + θ + N n) dx = n( 1 + θ ). Combnng (2), (3) and (7) n the dentty dp dp dx produces: dx (8) dp n ρk 1+ θ + N s = 2. ( 1+ ) It s possble to solate the effect of changes n subsdes on frm profts by dfferentatng (1) wth respect to s: d π dp dx 1 ρ. (9) = x ( p wl) + x ( + s) + [( p wl)( 1+ s) k] Equaton (3) mples that: (10) dx = dp + dp dx ρk 2 ( 1+ s) ( ). 1+ θ Together, (2), (8), (9) and (10) mply: dπ (11) = x [ p wl] whch n turn can be nterpreted as: + x ρk 2n ( ) 1 1+ s 1+ θ + N, (12) dπ = π ρk 1+ θ + N n + 2x ( 1+ s) ( 1+ s) 1+ θ + N. lnear. 6
Equaton (12) ndcates that the mpact of export subsdes on frm proftablty s a functon of the extent to whch competton n frm 's product market s mperfectly compettve and the prevalence of Amercan frms n 's product market. The mpact of subsdes on frm profts mpled by equaton (12) s usefully consdered n three lmtng cases of market structure and the prevalence of Amercan frms. Frst, n the case n whch Amercan frms are greatly outnumbered by foregn compettors ( n 0), (12) becomes dπ π + 2x ρk =, regardless of the value of θ. Inspecton of equatons (8) and (10) reveals ( 1+ s) why profts respond to hgher subsdes n ths way. Output prces do not react to changes n s, allowng Amercan frms to realze the full beneft of the product of the subsdy and taxable π x K export profts (equal to + ρ ). At the same tme, Amercan frms ncrease ther output and 1+ s ( ) x ρk. + s acqure market share from ther foregn compettors, the value of whch equals ( 1 ) Together, these two consderatons account for the total change n exporter profts. In cases n whch Amercan frms domnate the export market ( n N ), market structure matters crucally. Under perfect competton ( θ = 1), dπ π = ( 1+ s) = 0, as any beneft of the subsdy s passed on to consumers (and π = 0 f the market s perfectly compettve and domnated by Amercans). In contrast, wth θ = 0, the case of monopoly (N=1) collapses to dπ = ( 1+ s) π dπ π + xρk = = x + 2x ρk ( 1+ s) ( 1+ s)( 1+ N ) [ p wl] 1. In the case of a, whch, n monopolst, the envelope theorem apples: the value of a change n the subsdy rate equals the addtonal subsdy that would be receved assumng no behavoral response. More generally, as Amercan frms consttute more of the market, market structure begns to dctate the ncdence of the subsdy, less compettve market structures correspondng to greater mpact of subsdes on proftablty. 7
In order to use stock market data to measure the mpact of export subsdes on proftablty, t s necessary to recast the relatonshp expressed n equatons (11) and (12) as a functon of changes n share prces rather than smply profts. Ths exercse yel smlar ntutons but s useful n resolvng the potental confuson arsng from the fact that subsdes are functons of profts. For ths purpose, t smplfes notaton to consder the mpact of small changes n export subsdes around the pont that s = 0. The value of a frm s shares equals the sum of economc profts and the value of ts nvested equty captal, whch can be denoted (n unts of annual flows) by v. Lettng σ denote frm s value from everythng other than profts on exports, π + = + σ π σ 1. For a fxed stock of equty (whch s approprate n σ v = consderng share prce changes), and for π small relatve to σ, then gven that π σ d log v logσ +, and = 0 σ d ( logv ), the effect of export subsdes on frm valuaton s dπ. If each frm has roughly smlar markups over labor cost for ts export and σ non-export sales, then ( p wl) z (11) mples: σ, n whch z s frm s non-export sales. Consequently, (13) d logv x 1 + z ρk 1+ θ + N 2n ( p wl) 1+ θ + N. Equaton (13) explans the mpact of export subsdes on stock market valuaton as a functon of the fracton of a frm s sales devoted to exports and a term that captures the degree of dp p. Normalzng dx competton n the frm s markets. From equaton (2), ( wl) = ρ k x ( 1+θ ) the ntal output prce to be unty ( p 1) notng that x 1 =, (13) becomes: X N d logv Dfferentatng both sdes of (13) wth respect to θ produces:, defnng the nverse demand elastcty η x 1 1+ θ + N 2n 1 + ( + ) + +. z η 1 θ 1 θ N 1 ρkn dp dx X p, and 8
(14) 2 d logv x 1 2n( 1 µ ) + µ 2 2 dθ z ( 1+ θ + N ) ( 1 µ ) 1 ( 1+ θ + N )( 1+ θ + N 2n) ( + θ ), n whch ( + θ ) η µ 1. ρkn Equaton (14) ndcates that the effect of taxes on share valuaton depen on the extent to whch frms operate n mperfectly compettve envronments. Seade (1980) notes that stable equlbra requre that 0 µ, whch for downward-slopng demand curves ( < 0) η correspon to θ 1. Hence n ( 1+ θ + N ) 2 s a suffcent condton for the rght sde of (14) to be postve: a greater concentraton of Amercan frms n the export market ncreases the mpact of mperfect competton on share prce reactons to export subsdes. In order to estmate the relatonshp mpled by (14) t s necessary to have a measure of the extent of competton n a frm s export ndustry. In the absence of more drect measures, one usable proxy s frm s proft rate. Gven that (12) and (14) predct that market structure matters n stuatons n whch Amercan frms comprse a nontrval fracton of the frms n a gven product market, the correspondng emprcal strategy s to nvestgate the share prce mpact of the WTO controversy frst as a functon of the exposure of Amercan frms to exports and the usefulness of export tax subsdes. Subsequent analyss consders the mpact of market structure as proxed by average frm proftablty. 3. Amercan export ncentves 8 The Unted States subsdzes exports by exemptng export profts from U.S. taxaton and by permttng taxpayers to declare that a porton of export profts represents foregn source ncome; ths secton revews these provsons and ther mplcatons. 3.1 Subsdy by exempton of ncome: FSCs and ETI Snce 1971, frms exportng goo from the Unted States have been enttled to do so n a legally roundabout fashon that enables them to exempt a fracton of export profts from taxaton. 8 For a more complete hstory of tax subsdes for U.S. exports, see Desa and Hnes (2001a), from whch ths secton draws. 9
A frm receved tax benefts between 1971 and 1984 by routng exports through Domestc Internatonal Sales Corporatons (DISCs); between 1984 and 2000, smlar tax benefts were avalable by routng exports through FSCs. For example, an Amercan computer company sellng a computer manufactured n Texas to a buyer n northern Italy n 1997 mght frst sell the computer to ts FSC located n Guam, whch n turn sold the computer to the buyer n Italy. The computer dd not travel to Guam n the course of ths sale, nor was t necessary that any substantal busness be conducted at the FSC offces located n Guam; nstead, these were paper transactons. As a result, a porton (roughly 15 percent) of the export proft was attrbuted to the FSC and forever exempt from tax. 9 In November 2000 the Unted States contnued FSCs, replacng them wth an automatc 15 percent exempton of extraterrtoral ncome (ETI) from U.S. taxaton. ETI conssts of ncome earned by exportng goo from the Unted States, as well as ncome earned by foregn afflates operatng abroad. Snce most exporters had prevously used FSCs to exempt 15 percent of ther export profts from U.S. taxaton, the elmnaton of FSCs and ther replacement by an exempton for 15 percent of ETI dd not substantally change the tax beneft assocated wth exportng. 3.2 Subsdy by allocaton of ncome: Export source rules An entrely separate type of export subsdy s avalable to Amercan multnatonal frms wth excess foregn tax credts. The nature of the subsdy s that part or all of export profts can be treated as foregn source ncome for the purpose of U.S. ncome taxaton. Ths export subsdy s more generous to qualfyng frms than was the subsdy provded by the use of FSCs or the more recent automatc exempton of 15 percent of export profts. Snce many Amercan multnatonal frms have excess foregn tax credts, 10 and the parent companes of Amercan multnatonal frms account for 58 percent of all U.S. exports of goo, 11 t follows that ths 9 The tax benefts of exportng through FSCs were avalable to all corporatons n the Unted States, ncludng those that were foregn-owned. Belmonte (2000) provdes aggregate data on the use of FSCs n 1996. See Desa and Hnes (2001a) for a detaled descrpton and analyss of FSC rules that permtted some taxpayers to exempt from U.S. taxaton a fracton greater than 15 percent of export ncome. 10 See the data reported by Grubert (2001). 11 See the data for 1997 reported n Matalon (1999, p. 14). 10
export subsdy s potentally qute mportant. Notably, ths export subsdy s not avalable to Amercan exporters that are not multnatonal frms. In order to understand the tax subsdy avalable from the foregn source rules, and the crcumstances under whch taxpayers mght be elgble for the assocated tax benefts, t s necessary to revew certan aspects of U.S. taxaton of the foregn ncome of Amercan taxpayers. A bref descrpton of some of the relevant features follows. 12 3.2.1 The foregn tax credt The Unted States taxes the foregn ncomes of ts resdent companes, permttng them to clam foregn tax credts for ncome taxes (and related taxes) pad to foregn governments. These foregn tax credts are used to offset U.S. tax labltes that would otherwse be due on foregnsource ncome. The U.S. corporate tax rate s currently 35 percent, so an Amercan corporaton that earns $100 n a foregn country wth a 10 percent tax rate pays taxes of $10 to the foregn government and $25 to the U.S. government, snce ts U.S. corporate tax lablty of $35 (35 percent of $100) s reduced to $25 by the foregn tax credt of $10. The U.S. tax lablty on such foregn ncome s typcally deferred untl profts are repatrated n the form of dvden. 13 3.2.2 Excess foregn tax credts Because the foregn tax credt s ntended to allevate nternatonal double taxaton, and not to reduce U.S. tax labltes on profts earned wthn the Unted States, the credt s lmted to U.S. tax lablty on foregn-source ncome. For example, an Amercan frm wth $200 of foregn ncome that faces an U.S. tax rate of 35 percent has a foregn tax credt lmt of $70 (35 percent of $200). If the frm pays foregn ncome taxes of less than $70, then the frm would be enttled to clam credts for all of ts foregn taxes. If, however, the frm pays $90 of foregn taxes, then t would be permtted to clam no more than $70 of foregn tax credts. Frms calculate foregn tax credts based on ther total (worldwde) foregn ncomes and foregn tax payments (subject to certan restrctons). Taxpayers whose foregn tax payments exceed the foregn tax credt lmt are sad to have excess foregn tax credts; the excess foregn tax credts 12 Portons of ths descrpton are excerpted from Hnes (1999). 13 For analyses of the effect of taxaton and deferral on dvdend repatratons, see Hnes and Hubbard (1990), Altshuler and Newlon (1993), Altshuler, Newlon and Randolph (1995) and Desa, Foley and Hnes (2001). 11
represent the porton of ther foregn tax payments that exceed the U.S. tax labltes generated by ther foregn ncomes. 3.2.3 Source rules and excess credts U.S. tax law embodes the prncple that the locaton of ncome arsng from a sale s determned, n part, by the ste of the sale rather than the ste of producton. Secton 863(b) of the Internal Revenue Code provdes that half of profts earned on goo exported from the Unted States wll be deemed to have foregn source f the taxpayer elects to pass the export ttle (a purely formal acton) n the foregn locaton rather than n the Unted States. Frms wth excess foregn tax credts can use ths source rule to reduce U.S. taxes otherwse due on export profts. The beneft to a frm wth excess foregn tax credts of attrbutng half of export ncome to foregn source s llustrated by the comparson presented n Table 1. The Amercan multnatonal frm n ths example earns $40 by exportng from the Unted States and an addtonal $100 from the operatons of ts foregn afflate. The foregn afflate s located n a country wth a 50 percent tax rate, whch, snce t excee the U.S. tax rate of 35 percent, mples that the parent company has $15 of excess foregn tax credts. If export profts are treated as domestc ncome, then the frm s $40 of export ncome s fully taxed at the domestc tax rate of 35 percent, resultng n a tax lablty of $14. If nstead the exporter can characterze 50 percent of export profts as havng foregn source, then $7 of the frm s excess foregn tax credts can be appled aganst the U.S. tax lablty on export profts, leavng a net tax lablty of $7 on export profts. 14 Therefore, frms wth excess foregn tax credts are able to sheld 50 percent of ther export profts from U.S. taxaton by takng advantage of the opportunty provded by secton 863(b). 3.3 Incentves for exporters and the prevalence of export subsdes Snce 1971, Amercan exporters have been faced wth the envable choce between two export tax benefts: the partal exempton of export ncome, and the allocaton of half of export ncome to foregn source under secton 863(b). These possbltes are exclusve, n that the same 14 An mportant aspect of ths beneft s that foregn governments do not coordnate ther taxaton of export ncome wth the Unted States. Thus, the electon by an Amercan taxpayer to treat $20 of export profts as havng foregn source for U.S. tax purposes has no effect on any foregn taxes that the taxpayer may owe. 12
dollar of export ncome cannot beneft from both subsdes. For frms wthout excess foregn tax credts, the export source rules do not offer the prospect of reduced U.S. tax labltes, snce ncome allocated to foregn source s nonetheless mmedately taxed by the Unted States. From 1984-2000, such frms dd better to route ther exports through FSCs, n whch case they were elgble for a 15 percent excluson of export profts from U.S. taxaton. Frms wth excess foregn tax credts could beneft from the foregn source allocaton rule under 863(b) to allocate 50 percent of export profts to foregn source and thereby exclude 50 percent of export profts from U.S. taxaton. The two columns of Fgure 1 summarze an exporter s tax optons as of 1997. A 15 percent exempton of export ncome was avalable regardless of a frm s excess foregn credt status, though f the exporter was a multnatonal frm wth excess foregn tax credts, 50 percent of export ncome could escape taxaton through the use of 863(b). There are two mportant complcatons to ths otherwse smple story, the frst stemmng from the fact that a frm s excess foregn tax credt status may change over tme and s tself a functon of many decsons that the frm makes every year. Such decsons nclude where to locate foregn operatons, whether to fnance foregn operatons wth debt or equty, how many dvden to repatrate from each of ts foregn subsdares, and what costs (such as nterest expenses or R&D expenses) the frm wll ncur n the Unted States and allocate n part aganst foregn ncome. Furthermore, excess foregn tax credts can be carred back two years and forward fve. As a result, tnctons between frms wth excess foregn tax credts and those wth defct foregn tax credts are only mperfectly captured by measured tax postons n any sngle year. 15 The second complcaton s that the U.S. corporate ncome tax s asymmetrc, n that proftable corporatons must pay corporate taxes whle corporatons makng losses do not receve refun. Corporatons wth losses are permtted to carry them back aganst taxable ncome earned n any of the prevous two years, thereby enttlng them to refun for taxes prevously pad. If current tax losses exceed taxed ncome from the prevous two years, then a corporaton s permtted to carry ts losses forward (wthout nterest) to apply aganst taxable ncome earned 15 For an elaboraton of ths pont see the cusson Scholes et al. (2002). 13
n subsequent years. Frms wth such net operatng loss carryforwar are effectvely untaxed untl (and unless) they return to proftablty at some pont n the future. Export tax subsdes are of consderably less value to such frms than they are to frms wthout net operatng loss carryforwar, snce the expected present value of a current tax beneft s reduced by nomnal countng to the date at whch the frm agan becomes taxable, whch could be never. All other thngs equal, the threatened removal of export subsdes should therefore have much smaller effects on frms wth sgnfcant net operatng loss carryforwar than they do on other frms. 4. Data and Results Ths secton evaluates the ncdence of U.S. export subsdes by examnng the determnants of abnormal stock market returns on November 18, 1997, the date of the surprse European announcement of ts ntenton to fle a complant aganst the U.S. FSC program. 4.1 Data descrpton In order to match stock prce reactons to frm attrbutes t s necessary to combne balance sheet and ncome statement data from Compustat wth stock return data from CRSP. Snce export exposure s central to ths study, frms are ncluded n the sample only f they have complete export data (whch may be zero exports) contnuously from 1992 to 1998, a restrcton that reduces the sample sze to 691 frms. Share prces exhbt daly fluctuatons for reasons that are unrelated to government polcy. In calculatng abnormal stock returns for November 18, 1997 t s mportant to adjust ndvdual stock prce movements for changes attrbutable to movements n aggregate stock ndces or the value of the U.S. dollar aganst foregn currences. Daly stock prce returns for the 400 tradng days pror to November 18, 1997 were regressed separately for each frm on contemporaneous daly changes n the S&P 500 ndex and changes n the dollar-pound sterlng exchange rate. The resultng frm-specfc coeffcents were then used to create predcted stock returns for November 18, 1997 based on changes that day n the S&P 500 ndex and the value of the U.S. dollar. Dfferences between actual returns and predcted returns represent abnormal returns for that day. 14
Table 2 presents summary statstcs for varables used n the regressons. Export propensty s measured as the 1997 rato of exports to sales; ths varable has a sample mean of 0.163 and a medan of 0.1144. A frm s tax poston, as measured by ts rato of net operatng loss carryforwar to sales, has a mean of 0.29 and a medan of zero. The degree of multnatonalty, as measured by the rato of foregn to total assets, has a mean of 0.10 and a medan of zero. The average foregn tax rate n 1997 s defned as the rato of foregn ncome tax payments to foregn pretax ncome; ts mean s 34.0 percent, and medan s 33.2 percent. The average foregn tax rate varable s avalable for only 202 frms. The average pretax proft margn s the 1992-1998 mean rato of pretax profts to total sales; ths varable has a mean of 5.8 percent and a medan of 6.6 percent. It s nstructve to examne unadjusted stock prce reactons on November 18, 1997. 16 The U.S. stock market fell on that day, the S&P 500 fallng by $61 bllon, or 0.76 percent of ts aggregate value. 17 Fgure 2 depcts average (unweghted mean) daly returns for four subsamples of frms, tngushed by exportng propensty and the presence of net operatng loss carryforwar. Frms classfed as major exporters are those whose export/sales ratos exceed the sample medan of 0.1144; mnor exporters have export/sales ratos below 0.1144. Shares of major exporters showed the greatest prce declnes on November 18, 1997, partcularly those wthout net operatng loss carryforwar, whose average share prce fell by 0.80 percent. Share prces of mnor exporters wthout net operatng loss carryforwar fell by just 0.23 percent. Among frms wth net operatng loss carryforwar, share prces of major exporters fell by more than dd the share prces of mnor exporters, but the dfference between them s consderably smaller than n the case of frms that are currently taxable. Ths prce movement pattern s consstent wth changes n after-tax proftablty that are lkely to be assocated wth the WTO acton by the European Unon, snce tax benefts are less valuable to frms wth net operatng loss carryforwar than they are to others. 16 The pattern of abnormal returns s almost dentcal to that of unadjusted returns. 17 It s noteworthy that the $61 bllon loss of aggregate stock market value on November 18, 1997 approxmately equals the present value of the estmated $4 bllon annual flow of FSC tax benefts to U.S. exporters, counted at the prevalng 30-year AAA corporate bond rate of 6.84 percent. Whle $4 bllon per year s a conservatve estmate of FSC benefts (see Desa and Hnes, 2001a), and the benefts were lkely to grow sgnfcantly over tme, the WTO complant by the European Unon dd not necessarly mply that the export benefts would be mmedately or permanently removed. 15
4.2 Determnants of abnormal returns Table 3 presents regressons n whch the dependent varable s a frm s abnormal stock return on November 18, 1997. The sole ndependent varable n the regresson n column 1 s a frm s export/sales rato; ts estmated coeffcent s -0.0198, though not statstcally dfferent from zero. The regresson reported n column three ncludes two addtonal ndependent varables: the net operatng loss rato and an nteracton of the net operatng loss rato and the export rato. The estmated coeffcents reported n column three confrm the vsual pcture provded by Fgure 2: the coeffcent on the export rato s negatve (though statstcally nsgnfcant), the coeffcent on the net operatng loss varable s negatve, and the coeffcent on the nteracton of the export rato and net operatng losses s postve. These coeffcent estmates mply that abnormal daly returns of exportng frms dffered between those wth and wthout sgnfcant net operatng loss carryforwar. The regressons reported n columns 4-7 add control varables that mprove the ft of the regresson and contnue to mply that share prces fell most sharply for frms most at rsk from the threatened removal of export tax benefts. The rato of foregn to total assets ndcates the extent to whch a frm has nternatonal producton and therefore the ablty to substtute foregn producton for domestc exports, as well as the possblty of generatng excess foregn tax credts that make the export source rule more attractve than exportng through FSCs. Hence large values of the nteracton of foregn assets and the export rato should be assocated wth smaller share prce effects of FSC removal, and therefore a postve coeffcent n the regresson. Log assets s ncluded as an ndependent varable to control for any pure sze effects that mght be correlated wth export propenstes, net operatng loss carryforward status, or foregn asset fracton. The negatve effect of export shares on daly share prce returns becomes statstcally sgnfcant n the regressons reported n columns 5-7, whle other varables have expected sgns and magntudes. It s useful to consder the economc nterpretaton of the magntudes of the estmated coeffcents reported n column 6. The -0.0283 coeffcent on the export rato suggests that a frm wth one hundred percent exports would suffer a 2.83 percent negatve abnormal share return relatve to the same frm wth no exports. In prncple, frms could use FSCs to reduce 16
taxable ncome by roughly ffteen percent of export profts, whch at a 35 percent tax rate correspon to a tax savng of 5.25 percent of export profts, or 8.08 percent of after-tax export profts. 18 Hence the estmated effect of the WTO event s just 35 percent (2.83/8.08) of the proftablty mpact of an unexpected and permanent removal of export tax benefts. Ths smaller effect s attrbutable n part to uncertanty over the ultmate resoluton of the FSC pute, and the long delays n mplementng any changes that reduce the present value of ther mpact. Furthermore, removal of export tax benefts should occason a fall n the value of the U.S. dollar relatve to other currences, 19 thereby offsettng a porton of the cost to exporters. Fnally, endogenous behavoral shfts on the part of exporters are lkely to attenuate at least some of the costs of losng the export subsdes. The estmated 0.0049 coeffcent on the nteracton of the net operatng loss rato and the export rato can be understood by comparng t to the export rato coeffcent. Gven that the export rato coeffcent s 5.8 tmes larger n magntude, the mplcaton s that a frm wth net operatng loss carryforwar equal to 5.8 tmes annual sales would be fully nsulated from any adverse prce effect assocated wth the loss of export tax subsdes. Certanly such a frm s unlkely to return to taxpayng status any tme soon, though there s always the possblty that frms wth ample net operatng loss carryforwar mght be acqured by taxable frms who can use the losses to reduce tax oblgatons on ther own ncome. 20 The regressons presented n Table 3 offer evdence that the U.S. share prces reacted to the news of November 18, 1997 n a manner that s consstent wth the proftablty mplcatons of losng FSC tax benefts. Table 4 presents smlar regressons for abnormal Japanese share prce movements on November 19, 1997 (the frst Japanese tradng day that could ncorporate news of the European Unon announcement), calculatng one-factor abnormal returns based on covarance wth the Nkke ndex. Snce the loss of U.S. tax benefts would not drectly affect 18 5.25/(1.0-0.35) = 8.08. 19 Desa and Hnes (2001b) offer evdence that the U.S. dollar fell on November 18, 1997 n a manner that s consstent wth the mpled mpact of the FSC pute. 20 For a more general cusson of mergers and tax loss carryforwar, see Auerbach and Reshus (1988). 17
Japanese exporters, 21 t s nstructve to compare the determnants of Japanese prce reactons to the determnants of Amercan prce reactons. Japanese frms do not report foregn assets or foregn tax payments, makng t mpossble to replcate exactly all of the regressons that can be run on Amercan frms, but the broad pattern of Japanese prce reactons s clear from Table 4. Share prces of Japanese exporters dd not exhbt abnormal declnes followng the European Unon announcement, and ndeed, all of the coeffcents reported n Table 4 are statstcally nsgnfcant and of the opposte sgns of ther counterparts n Table 3. Hence the drop n the share prces of exporters n the Unted States, who stood to lose tax benefts, was not repeated among exporters abroad who never had tax benefts to lose. 4.3 Frm Proftablty and Abnormal Returns Table 5 presents regressons n whch the November 18, 1997 abnormal returns to U.S. shares are regressed aganst varables ncludng foregn tax rates and total frm proft margns. The foregn tax rates facng Amercan exporters determne the desrablty of usng FSCs, snce frms whose foregn operatons are located n hgh-tax countres are very lkely to have excess foregn tax credts, and therefore beneft by avodng FSCs and nstead usng the source rule to characterze export profts as foregn ncome. Unfortunately, foregn tax rate nformaton s avalable only for 202 frms, so the sample for the regressons reported n Table 5 s consderably smaller than that for the regressons reported n Table 3. Column 1 of Table 5 reports estmated coeffcents from a regresson that ncludes as ndependent varables export ratos, foregn tax rates, and nteractons of these two varables. The 0.1509 coeffcent on the nteracton of the export rato and foregn tax rate mples that the negatve effect of greater exports s attenuated by havng hgher foregn tax rates, presumably because hgher tax rates reduce the value of exportng through FSCs. The regressons reported n columns 2-5 add as ndependent varables measures of pretax proft margns and ther nteractons wth export ratos. A frm s pretax proft margn s ts average rato of profts to sales over the 1992-1998 perod, and serves as a proxy for market structure (hgher profts 21 Japanese frms wth afflates n the Unted States were enttled to use FSCs for ther U.S. exports, and therefore stood to lose tax benefts, but ths would represent a very small fracton of ther total value. 18
correspondng to less compettve markets). 22 The estmated effect of the nteracton of the export rato and the foregn tax rate remans postve wth the ncluson of proftablty varables and others n the regressons reported n columns 2-5. Share prces of proftable frms dd not exhbt abnormal returns on November 18, 1997 that dffered systematcally from those of less proftable frms, but share prces of more proftable frms wth sgnfcant exports fell on that day. The estmated negatve coeffcents on nteractons of export ratos and proftablty n the regressons reported n columns 2-5 ndcate that the combnaton of export exposure and hgh proft margns s assocated wth share value losses (though the coeffcent on the nteracton s statstcally nsgnfcant n the regresson reported n column 3). Frms operatng n less compettve markets are lkely to mantan hgh proft margns over tme, and as outlned n secton 3, market structure s an mportant determnant of the predcted mpact of the WTO event on shares prces to the extent that Amercan frms comprse a nontrval fracton of the frms competng n a gven ndustry. The regresson reported n column 5 of Table 5 ncludes controls for the effect of net operatng losses, the magntude of foregn assets, and total frm sze, wth an estmated 0.1878 coeffcent on the nteracton of average frm proftablty and the export rato. The magntude of ths estmated effect can be evaluated by comparng t to the ntal fndng of a 2.83 percent fall n market valuaton for an export-only frm (relatve to a frm wth no exports). The 0.1878 coeffcent on the nteracton term suggests that a three percent hgher pretax proft margn (for example, the dfference between 4.3 percent and 7.3 percent) ncreases by 20 percent the share prce mpact assocated wth exports. 23 Whle t s dffcult to map dfferences n proftablty to measurable features of market structure, a proft margn dfference of three percent s sgnfcant relatve to the sample mean of 5.8 percent, and has a correspondngly sgnfcant estmated effect on the relatonshp between export exposure and share prce reactons. 22 Proftablty s an mperfect ndcator of the extent of competton, but alternatves such as concentraton ndces are lkewse problematc and cannot be constructed at the frm level for major exporters that operate n multple ndustres and markets, only some of whch are publcly reported. Smlar consderatons make t mpossble to control drectly for frm-level dfferences n the extent to whch export markets are domnated by Amercan frms, so the proftablty varable s a nosy measure of market consderatons that are relevant to the lkely share prce mpact of export subsdes. 23 0.03(0.1878)/0.0283 = 0.20. 19
The WTO event caused frms to be revalued n a way that suggests that the stock market perceved export subsdes to be most valuable to frms operatng n mperfectly compettve markets. Stock market reactons reflect the behavor of market partcpants, as expressed by ther wllngness to buy and sell shares, so they are nformatve about market belefs and not necessarly the true state of the economy. These market reactons nonetheless offer useful nformaton about the lkely mpact of polcy changes, snce traders have ncentves to prce securtes accurately and to acqure the nformaton necessary to do so. 5. Concluson Ths paper offers evdence of the mportance of export subsdes to Amercan exporters. Stock prce movements on November 18, 1997 mply that the threatened elmnaton of Foregn Sales Corporatons reduced the values of frms wth large export exposures, those whose tax stuatons rewarded the use of FSCs, and those wth market postons that made them hghly proftable. The emprcal strategy used to estmate share prce reactons on November 18, 1997 combnes the asset prcng approach to tax ncdence (Summers, 1981, 1985; Cutler 1988) wth the strategc trade lterature s emphass on the mportance of mperfect competton. By comparng predcted abnormal returns wth the effects of mtgatng factors such as net operatng loss carryforwar and the avalablty of substtute export subsdes, t s possble to sharpen estmates of the value of FSCs. The correlaton of prce movements and frm proftablty mples that the stock market beleves export subsdes to beneft frms wth strong market postons, suggestng that home country export polces could be desgned to ad domestc frms from a strategc trade polcy perspectve. The use of the ncome tax system to subsdze exports s just one example of the connecton between trade polcy and broader domestc polces noted by Bhagwat and Ramaswam (1963) and numerous subsequent observers. In a world where ad valorem subsdes are beng negotated away, corporate tax polces are ncreasngly vewed as nstruments of nternatonal competton, not only to prevent taxaton from mpedng the ablty of domestc frms to compete n global markets, but also to enhance ther compettve postons. Whle analyses such as Bagwell and Stager (2001) and Ederngton (2003) consder how domestc 20
polces such as labor standar and envronmental polces mght be ncorporated nto multlateral arrangements, the embeddng of subsdes n corporate taxes rases a number of new ssues, possbly strengthenng calls for the coordnaton of corporate tax polces. These corporate tax ssues, ncludng ther mplcatons for savng and nvestment and the mplct ndexng of subsdes to proftablty, are lkely to receve sgnfcant attenton gven the magntude and mpact of subsdes such as those hstorcally provded to exports under the U.S. ncome tax. 21
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Fgure 1: Overvew of Incentves for Exporters, 1984-2000 FSC Secton 863(b) Texas Texas Guam Italy Italy 15% of export profts exempt from 50% of export profts exempt from U.S. taxaton U.S. taxaton Valuable to all taxable frms Valuable only to frms wth excess foregn tax credts Requres use of FSC Requres that ttle to export property be passed n foregn locaton Note: The fgure depcts the two alternatve export subsdes avalable to U.S. exporters from 1984 to 2000. The left column depcts the use of a Foregn Sales Corporaton (FSC) and the characterstcs of that export subsdy. The rght column depcts the use of allocaton of export ncome to foregn source under Secton 863 (b) and the characterstcs of that export subsdy.
Fgure 2: Stock Prce Returns for Major and Mnor Exporters, by Tax Loss Status, November 18, 1997 0-0.1-0.2-0.2263% Daly Return (%) for group medan -0.3-0.4-0.5-0.6-0.7-0.6740% -0.3770% Mnor Exporters (79 frms) Mnor Exporters (238 frms) -0.8 Major Exporters (87 frms) -0.7976% -0.9 Major Exporters (225 frms) -1 Frms wth current net operatng losses Frms wthout current net operatng losses Note: The fgure depcts stock returns of Amercan frms on November 18, 1997, the day on whch the European Unon fled ts complant over the U.S. FSC program. The frst two bars are for frms wth net operatng losses n 1997; the second two bars are for frms wthout net operatng losses. Major exporters have export to total sales ratos exceedng 11 percent; mnor exporters have export to total sales ratos of less than 11 percent. The bars depct the medan daly returns of frms n each group.
Table 1 The Benefts of Foregn Source Allocaton to Frms wth Excess Foregn Tax Credts Pretax Export Income Pretax Income From Foregn Subsdares Domestc Source Income Foregn Source Income Domestc Tax Rate Foregn Tax Rate After-Tax Net Income Excess Foregn Tax Credts Wthout Foregn Source Allocaton $40 $100 $40 $100 35% 50% $76= $50 ($100 x 50%) + $26 ($40 x 65%) $15 Wth Foregn Source Allocaton of 50% of Export Income $40 $100 $20 $120 35% 50% $83= $50 ($100 x 50%) + $20 ($20 x 0%) + $13 ($20 x 65%) $8 Note: The fgures above depct the tax payments assocated wth a frm wth excess foregn tax credts that receves both export ncome and dvdend repatratons from foregn subsdares. In the top row, there s no foregn source allocaton of export ncome. As a result, the frm has $15 ($100*(50%-35%)) n excess foregn tax credts. In the second row, foregn source allocaton of half of export ncome allows the exporter wth excess foregn tax credts not to pay taxes on the porton of export ncome allocated to foregn source. It s mportant to note that U.S. allocaton rules have no effect on foregn tax labltes.
Table 2 Varable Summary Statstcs Standard No. of Mean Medan Devaton Obs. Abnormal Returns, 11/18/97 (0.0046) (0.0012) 0.0376 648 Rato of Exports to Sales, 1997 0.1630 0.1144 0.1772 690 Rato of NOLs to Sales, 1997 0.2900 0.0000 2.6544 647 Interacton of NOLs and Export 0.0573 0.0000 0.5063 647 Rato Rato of Foregn Assets to Total 0.0997 0.0000 0.1700 691 Assets, 1997 Interacton of Foregn Asset 0.0117 0.0000 0.0298 690 Rato and Export Rato Foregn Tax Rate, 1997 0.3397 0.3323 0.2510 202 Interacton of Foregn Tax 0.0416 0.0251 0.0609 202 Rate and Export Rato Average Pretax Proft 0.0579 0.0662 0.1200 202 Margn, 1992-1998 Interacton of Pretax Proft 0.0074 0.0041 0.0297 202 Margn and Export Rato Log Total Assets, 1997 5.0835 4.9114 2.0658 648 Interacton of Foregn Asset Rato, 0.0015 0.0000 0.0305 647 Export Rato and NOL Rato Interacton of NOL Rato, 0.0015 0.0000 0.0146 202 Export Rato and Foregn Tax Rate Note: Abnormal returns on November 18, 1997 control for the effect of stock market and exchange rate movements on that day. "Rato of Exports to Sales, 1997" s the rato of exports to total sales n 1997. "Rato of NOLs to Sales, 1997" s the rato of net operatng loss carryforwar to sales n 1997. "Interacton of NOLs and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Rato of NOLs to Sales, 1997." "Rato of Foregn Assets to Total Assets, 1997" s the rato of foregn assets to total assets. "Interacton of Foregn Asset Rato and Export Rato s the product of "Rato of Exports to Sales, 1997" and "Rato of Foregn Assets to Total Assets, 1997. "Foregn Tax Rate, 1997" s the rato of foregn taxes pad to foregn pretax ncome. "Interacton of Foregn Tax Rate and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Foregn Tax Rate, 1997." "Average Pretax Proft Margn, 1992-1998" s the average of the annual ratos of total pretax profts to total sales from 1992 to 1998. "Interacton of Pretax Proft Margn and Export Rato" s the product of "Average Pretax Proft Margn, 1992-1998" and "Rato of Exports to Sales, 1997." "Log Total Assets, 1997" s the natural logarthm of total assets n 1997. "Interacton of Foregn Asset Rato, Export Rato, and NOL Rato" s the product of "Rato of Exports to Sales, 1997," "Rato of Foregn Assets to Total Assets," and "Rato of NOLs to Sales, 1997." "Interacton of NOL Rato, Export Rato and Foregn Tax Rate" s the product of "Rato of Exports to Sales, 1997," "Foregn Tax Rate, 1997," and "Rato of NOLs to Sales, 1997."
Table 3 Determnants of Abnormal Returns on November 18, 1997 Dependent Varable: One Day Abnormal Return from Two-Factor Model (1) (2) (3) (4) (5) (6) (7) Constant -0.0013-0.0010-0.0007 0.0000 0.0011-0.0016-0.0018 (0.0019) (0.0019) (0.0019) (0.0022) (0.0024) (0.0057) (0.0057) Rato of Exports -0.0198-0.0193-0.0222-0.0232-0.0292-0.0283-0.0280 to Sales, 1997 (0.0114) (0.0115) (0.0120) (0.0119) (0.0143) (0.0137) (0.0137) Rato of NOLs -0.0012-0.0016-0.0016-0.0017-0.0016-0.0015 to Sales, 1997 (0.0004) (0.0002) (0.0002) (0.0002) (0.0002) (0.0002) Interacton of NOLs 0.0045 0.0045 0.0048 0.0049 0.0033 and Export Rato (0.0021) (0.0021) (0.0021) (0.0021) (0.0024) Rato of Foregn Assets -0.0068-0.0175-0.0200-0.0193 to Total Assets, 1997 (0.0067) (0.0095) (0.0108) (0.0108) Interacton of Foregn Asset 0.0943 0.0927 0.0815 Rato and Export Rato (0.0635) (0.0625) (0.0618) Log Total Assets, 1997 0.0006 0.0006 (0.0010) (0.0010) Interacton of Foregn Asset Rato, 0.0627 Export Rato and NOL Rato (0.0208) No. Obs. 647 647 647 647 647 647 647 R-Squared 0.0084 0.0157 0.0182 0.0192 0.0224 0.0232 0.0254 Note: The dependent varable n all specfcatons s the abnormal return on November 18, 1997, controllng for the effect of stock market and exchange rate movements on that day. "Rato of Exports to Sales, 1997" s the rato of exports to total sales n 1997. "Rato of NOLs to Sales, 1997" s the rato of net operatng loss carryforwar to sales n 1997. "Interacton of NOLs and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Rato of NOLs to Sales, 1997." "Rato of Foregn Assets to Total Assets, 1997" s the rato of foregn assets to total assets. "Interacton of Foregn Asset Rato and Export Rato s the product of "Rato of Exports to Sales, 1997" and "Rato of Foregn Assets to Total Assets, 1997." "Log Total Assets, 1997" s the natural logarthm of total assets n 1997. "Interacton of Foregn Asset Rato, Export Rato, and NOL Rato" s the product of "Rato of Exports to Sales, 1997," "Rato of Foregn Assets to Total Assets," and "Rato of NOLs to Sales, 1997." Heteroskedastcty-consstent standard errors are n parentheses.
Table 4 Determnants of Abnormal Returns for Japanese Frms on November 19, 1997 Dependent Varable: One Day Abnormal Return from A One-Factor Model (1) (2) (3) (4) (5) (6) Constant -0.0066-0.0066-0.0067 0.0322 0.0335 0.0353 (0.0012) (0.0012) (0.0012) (0.0125) (0.0123) (0.0123) Rato of Exports 0.0036 0.0038 0.0037 0.0079 0.0085 0.0085 to Sales, 1997 (0.0052) (0.0053) (0.0053) (0.0054) (0.0054) (0.0055) Rato of NOLs 0.0013 0.0102 0.0035 0.0159 to Sales, 1997 (0.0047) (0.0159) (0.0053) (0.0168) Interacton of NOLs -0.0168-0.0231 and Export Rato (0.0231) (0.0244) Log Total Assets, 1997-0.0022-0.0023-0.0024 (0.0007) (0.0007) (0.0007) No. Obs. 1,202 1,202 1,202 1,202 1,202 1,202 R-Squared 0.0003 0.0004 0.0010 0.0074 0.0078 0.0091 Note: The dependent varable n all specfcatons s the abnormal return for Japanese frms on November 19, 1997, controllng for the effect of the local stock market on that day. "Rato of Exports to Sales, 1997" s the rato of exports to total sales n 1997. "Rato of NOLs to Sales, 1997" s the rato of net operatng loss carryforwar to sales n 1997. "Interacton of NOLs and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Rato of NOLs to Sales, 1997." "Log Total Assets, 1997" s the natural logarthm of total assets n 1997. Heteroskedastcty-consstent standard errors are n parentheses.
Table 5 Frm Proftablty and Abnormal Returns on November 18, 1997 Dependent Varable: One Day Abnormal Return from Two-Factor Model (1) (2) (3) (4) (5) Constant -0.0037-0.0041-0.0061-0.0088-0.0126 (0.0044) (0.0051) (0.0050) (0.0057) (0.0076) Rato of Exports -0.0241-0.0209-0.0179-0.0021-0.0008 to Sales, 1997 (0.0156) (0.0197) (0.0183) (0.0193) (0.0192) Foregn Tax Rate, 1997-0.0083-0.0109-0.0061-0.0065-0.0074 (0.0103) (0.0100) (0.0099) (0.0098) (0.0097) Interacton of Foregn 0.1509 0.1766 0.1335 0.1364 0.1383 Tax Rate and Export (0.0593) (0.0514) (0.0532) (0.0528) (0.0526) Rato Average Pretax Proft 0.0241 0.0266 0.0294 0.0259 Margn, 1992-1998 (0.0265) (0.0265) (0.0260) (0.0262) Interacton of Pretax -0.2230-0.1733-0.1914-0.1878 Proft Margn and (0.1064) (0.0983) (0.0912) (0.0916) Export Rato Rato of NOLs 0.0361 0.0391 0.0412 to Sales, 1997 (0.0705) (0.0723) (0.0725) Interacton of NOLs 0.1217 0.0982 0.0988 and Export Rato (0.2478) (0.2517) (0.2537) Rato of Foregn Assets 0.0109 0.0103 to Total Assets, 1997 (0.0134) (0.0137) Interacton of Foregn Asset -0.0793-0.0834 Rato and Export Rato (0.0662) (0.0660) Log Total Assets, 1997 0.0007 (0.0009) No. Obs. 202 202 202 202 202 R-Squared 0.0781 0.1099 0.1566 0.1623 0.1644 Note: The dependent varable n all specfcatons s the abnormal return on November 18, 1997, controllng for the effect of stock market and exchange rate movements on that day. "Rato of Exports to Sales, 1997" s the rato of exports to total sales n 1997. "Foregn Tax Rate, 1997" s the rato of foregn taxes pad to foregn pretax ncome. "Interacton of Foregn Tax Rate and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Foregn Tax Rate, 1997." "Average Pretax Proft Margn, 1992-1998" s the average of the annual ratos of total pretax profts to total sales from 1992 to 1998. "Interacton of Pretax Proft Margn and Export Rato" s the product of "Average Pretax Proft Margn, 1992-1998" and "Rato of Exports to Sales, 1997." "Rato of NOLs to Sales, 1997" s the rato of net operatng loss carryforwar to sales n 1997. "Interacton of NOLs and Export Rato" s the product of "Rato of Exports to Sales, 1997" and "Rato of NOLs to Sales, 1997." "Rato of Foregn Assets to Total Assets, 1997" s the rato of foregn assets to total assets. "Interacton of Foregn Asset Rato and Export Rato s the product of "Rato of Exports to Sales, 1997" and "Rato of Foregn Assets to Total Assets, 1997." "Log Total Assets, 1997" s the natural logarthm of total assets n 1997. Heteroskedastcty-consstent standard errors are n parentheses.