Page 409 - Special Topic Session (STS) - Volume 3

STS552 Carol C. Bertaut et al.
that collects cross-border flows and positions according to legal residence. This
legal residence concept is increasingly uninformative in a world of increasing
globalization and growing usage of offshore financial centers and low-tax
jurisdictions, because there is an increasing disconnect between the legal
residence and the economic exposure. Firms issuing securities may not do any
business at that legal residence, and thus ownership of such securities may say
little about the actual exposures investors face. Thus, even if efforts to improve
the country coverage are successful, official statistics will still provide an
increasingly distorted view of linkages and economic exposures.
Two main aspects of firm behavior lead to the distortions between country
residence and economic exposure that we observe in the cross-border portfolio
data. First, when able, multinational firms frequently locate in the jurisdiction with
the lowest tax rate; this is especially relevant for firms with substantial intangible
1
and other portable assets. As a result, cross-border statistics show elevated
holdings of securities from the Cayman Islands, Ireland, and other low-tax
jurisdictions which are associated with neither firm production nor expenses.
Such distortions are not new: Schlumberger, long one of the largest 100 global
firms, has operated in the U.S. since the 1930’s and is headquartered in Houston,
2
Texas, but has been incorporated in Curaҫao since 1956. As a result, U.S. cross-
border statistics have shown large holdings of Curaҫao equity for some time.
However, distortions have recently become more pronounced following a wave
of cross-border mergers and corporate “inversions”, whereby former U.S.-
resident firms have become foreign-resident firms after the merger. For
3
example, following recent high-profile inversions in the pharmaceutical industry
such as Actavis/Allergan and Medtronic/Covidien, the equity of several major
U.S. firms is now considered “Irish” equity according to official statistics. Adding
to these distortions is the increasing presence of emerging market economy
(EME) firms incorporated in the Caribbean. This is especially notable for some
large-cap Chinese firms including Alibaba, Baidu, and Tencent.
A second driver is firms seeking to improve their access to capital markets
and the pool of global bond investors. Many firms, particularly those in EMEs,
issue corporate bonds using a subsidiary firm located in a market outside their
home country. For this debt, the residence-based statistics will attribute
transactions and securities holdings to the location of the subsidiary. Factors
driving the use of offshore subsidiaries include improved pricing, access to

1 See for example the survey on the tax competition literature in Keen and Konrad 2013, as well
as Desai, Foley, and Hines 2006, Hebous and Johannesen 2016, Pomeroy 2016, Devereaux and
Vella 2017.
2 http://www.fundinguniverse.com/company-histories/schlumberger-limited-history/
3 “Inversions” refer to M&A activity where the acquiring firm is typically larger than the target
firm. After the merger, the combined firm “inverts” to establish its residence in the country of
the target firm, which is typically a lower-tax jurisdiction.
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