The Effect of Tax Avoidance on Capital Structure Choices
56 Pages Posted: 19 Jul 2019
Date Written: July 17, 2019
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: Suggested Citation