Do Credit Rating Agencies Care About Our International Tax Planning Strategy When Assigning Credit Ratings?

Abstract

International tax planning strategies, by their very nature, increase firms’ free cash flows, which could improve companies’ creditworthiness. However, these strategies also bring information and agency problems, which may reduce their creditworthiness. To understand which of these effects dominates, this study examines the effect of international tax planning on credit ratings. We find that credit analysts incorporate information related to international tax planning when analyzing a firm’s credit risk and that high international tax planning is associated with less favorable credit ratings. We also find that this effect is mitigated by a higher conflict of interest for the bond rating agencies. Furthermore, we find that the effect of international tax planning operates through the channels of future cash flow effects, agency costs, and information risk. Our results are robust to a difference-in-differences research design using The American Jobs Creation Act of 2004 as an exogenous shock to the benefits from international tax planning, and we document that the effect of international tax planning is different from and incremental to overall tax avoidance.

Keywords: Credit Ratings; International Tax Planning; Credit Quality; Multinational Firms

JEL Classification: G01, M4, H2, H25, K3, K34