Corporate Tax Avoidance and Public Debt Costs

59 Pages Posted: 6 Mar 2013 Last revised: 11 Aug 2013

Terry J. Shevlin

University of California-Irvine

Oktay Urcan

University of Illinois at Urbana-Champaign

Florin P. Vasvari

London Business School

Date Written: August 1, 2013

Abstract

We investigate the impact of corporate tax avoidance on the cost of public debt and provide evidence on the channels through which it affects the cost of debt. Although corporate tax avoidance increases current after-tax cash flows thus lowering default risk, it amplifies the uncertainty by negatively affecting future cash flows and it facilitates more opaque reporting. Using a large sample of US corporate bonds, we document that corporate tax avoidance is associated with higher bond offering yields. We also find that tax avoidance predicts lower and more volatile future cash flows and that approximately one third of the total effect of tax avoidance on the cost of public debt is explained through the negative effect of tax avoidance on future cash flows levels. Consistent with the lasting negative impact of tax avoidance activities on bondholders' wealth, we find that insurance companies, who are long term buy-and-hold bond investors, are less likely to own the bonds of the firms engaging in these activities. Additional cross sectional analyses indicate that corporate tax avoidance increases the cost of public debt especially when equityholders and the management have incentives to expropriate bondholders’ wealth and when the probability of an IRS audit is high.

Keywords: Corporate Tax Avoidance, Cost of Public Debt, Bond Ownership, Governance

JEL Classification: G31, G32, M10, O16

Suggested Citation

Shevlin, Terry J. and Urcan, Oktay and Vasvari, Florin P., Corporate Tax Avoidance and Public Debt Costs (August 1, 2013). Available at SSRN: https://ssrn.com/abstract=2228601 or http://dx.doi.org/10.2139/ssrn.2228601

Terry J. Shevlin (Contact Author)

University of California-Irvine ( email )

Paul Merage School of Business
Irvine, CA 92697-3125
United States
949-824-6149 (Phone)

Oktay Urcan

University of Illinois at Urbana-Champaign ( email )

1206 S. Sixth Street
Champaign, IL 61820
United States
217-265-0383 (Phone)
217-244-0902 (Fax)

Florin P. Vasvari

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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