The Effect of Foreign Cash Holdings on Internal Capital Markets and Firm FInancing

Prior literature demonstrates that firms should use internal capital before accessing costly external finance. However, prior to 2018, the U.S. repatriation tax imposed an internal capital market friction on U.S. multinational firms (MNCs), thereby motivating companies to retain cash offshore. We quantify the extent to which U.S. MNCs used domestic financing rather than incur the repatriation tax to meet domestic cash needs. We find that firms with high tax-induced foreign cash have approximately 3.0 percent higher domestic liabilities relative to other MNCs, equivalent to $138.4 million more of domestic debt per firm, or approximately $89.9-$129.0 billion in aggregate. We also show that this effect occurs primarily for the subset of firms financing shareholder payouts, with weaker evidence for financing domestic M&A and R&D activity. The evidence informs expectations of responses to the recent U.S. tax law by quantifying the extent that firms will likely reduce domestic debt with repatriated funds as opposed to the intended responses of increasing domestic investment and employment.