Firm-wide Effects of Earnings Stripping Rules

This paper estimates the impact of the earnings stripping rule reform by the ATAD Directive on the firm-wide external debt ratio of large multinational firms in the European Union in 2019. The analysis is based on the consolidated financial statements of STOXX Europe 600 constituents in 12 different Member States between 2014 and 2022. Firms that were not subject to a limitation of total interest expenses before the reform reduced their external debt ratio by 2.1 percentage points on average, which indicates an 8.3 percent decrease based on the pre-reform average external debt ratio of treated firms. The effect is lower at 1.3 percentage points but equally significant upon variations in the control group. The estimation results indicate that firms restricted in only internal interest expenses before the reform, firms in sink tax havens, and firms in industries with naturally higher net-interest-to-EBITDA ratios were particularly strongly affected by the reform. The findings suggest that the earnings stripping rule reform in the European Union significantly affected the external tax-related debt bias of large multinational firms. Keywords: capital structure; earnings stripping rule; interest limitation; tax avoidance