830 Part Ten Mergers, Corporate Control, and Governance
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tax rate. One year later the company acquired Forest Labs, which as a result also changed its
headquarters to Ireland.
Both deals were examples of tax inversion. The United States taxes corporate profits even
if the profits are earned overseas.21, 22 Other countries tax only profits that are earned domes-
tically. When a U.S. corporation moves abroad because of a merger, it must still pay U.S. tax
on its U.S. profits, but it no longer pays U.S. tax on profits earned elsewhere. Since the corpo-
rate tax rate in the U.S. is much higher than in most other developed countries, there has been
a strong incentive for companies to move their domicile abroad.
A spate of large tax inversion deals in 2013 and 2014 prompted concerns about the loss
of tax revenue and accusations of unpatriotic corporate behavior. So, when Pfizer announced
that it planned to merge with the British company, Astra Zeneca, and move its headquarters to
the U.K., the government enacted several regulations to limit tax inversion. Prior tax-inversion
deals were not affected by the new regulations.
The new regulations do not change an awkward and illogical tax situation. Suppose U.S.
corporation A acquires Swedish corporation B. Then A is sooner or later liable for U.S. taxes
on B’s Swedish profits. (We assume that those profits cannot be left abroad forever.) But
suppose B buys A. Then A’s profits are taxed at the U.S. rate, just as before, but there are no
U.S. taxes on B’s income in Sweden, where the corporate tax rate is 22%. Thus there is a tax
incentive for foreign companies to buy U.S. companies, but not vice versa.(^21) For example, suppose a U.S. corporation earns $100 in Ireland. It pays $12.50 Irish tax. If it then repatriates the profits of $100, it
gets a $12.50 credit against U.S. taxes. Suppose the marginal U.S tax rate is 35%. Then the U.S. tax is .35 × 100 − 12.50 = $22.50.
(^22) But the U.S. tax on foreign profits is not paid until the profits are brought home. The tax can be postponed by reinvesting in Ireland
or other foreign countries. Many large U.S. companies have therefore accumulated “cash mountains” overseas. The cash at least earns
interest and can be used for foreign capital investment or acquisitions when opportunities arise.
31-5 Proxy Fights, Takeovers, and the Market for Corporate Control
The shareholders are the owners of the firm. But most shareholders do not feel like the boss,
and with good reason. Try buying one share of IBM stock and marching into the boardroom
for a chat with your employee, the CEO. (However, if you own 50 million IBM shares, the
CEO will travel to see you.)
The ownership and management of large corporations are separated. Shareholders elect the
board of directors but have little direct say in most management decisions. Agency costs arise when
managers or directors are tempted to make decisions that are not in the shareholders’ interests.
As we pointed out in Chapter 1, there are many forces and constraints working to keep
managers’ and shareholders’ interests in line. But what can be done to ensure that the board
Taxable Merger Tax-Free Merger
Impact on
Captain B
Captain B must recognize a $30,000
capital gain.
Capital gain can be deferred until Captain B sells the
Baycorp shares.
Impact on
Baycorp
Boat is revalued at $280,000.
Tax depreciation increases to
$280,000/10 = $28,000 per year
(assuming 10 years of remaining life).
Boat’s value remains at $150,000, and tax
depreciation continues at $15,000 per year.
❱ TABLE 31.4^ Possible tax consequences when Baycorp buys Seacorp for $330,000.
Captain B’s original investment in Seacorp was $300,000. Just before the merger
Seacorp’s assets were $50,000 of marketable securities and one boat with a book value
of $150,000 but a market value of $280,000.