The Effect of Tax Avoidance on Capital Structure Choices

56 Pages Posted: 19 Jul 2019

See all articles by Yoojin Lee

Yoojin Lee

California State University, Long Beach

Terry J. Shevlin

University of California-Irvine

Aruhn Venkat

University of California, Irvine

Date Written: July 17, 2019

Abstract

In this study, we examine whether tax avoidance affects firm-level external financing choices. We hypothesize that firms marginally choose equity over debt because tax avoidance generates incremental cash flows but is likely risky. Consequently, we predict that tax avoidance induces a relative price increase in debt relative to equity. Our results are consistent with tax avoidance inducing firms to choose equity over debt. Importantly, our theory and results are distinct from the effects of marginal tax rates on capital structure (e.g., Modigliani and Miller 1963) and we control for marginal tax rates in all specifications. From an identification standpoint, we use path analyses, a plausibly exogenous 9th Circuit decision and cross-sectional tests to support our main results. To our knowledge, our study is the first to examine the relationship between capital structure decisions and tax avoidance.

Keywords: tax avoidance, cost of capital, debt and equity financing

JEL Classification: G32, H26, M41

Suggested Citation

Lee, Yoojin and Shevlin, Terry J. and Venkat, Aruhn, The Effect of Tax Avoidance on Capital Structure Choices (July 17, 2019). Available at SSRN: https://ssrn.com/abstract=3422616 or http://dx.doi.org/10.2139/ssrn.3422616

Yoojin Lee (Contact Author)

California State University, Long Beach ( email )

1250 Bellflower Blvd
Long Beach, CA 90064
United States

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

Aruhn Venkat

University of California, Irvine ( email )

Irvine, CA
United States
9498246149 (Phone)
92697 (Fax)

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