Tax Shields Under Siege: The Effect of Limiting Interest Deductibility on Commercial Lending Negotiations 

Abstract

This paper examines how tax policy affects borrower-lender negotiations in syndicated loan markets. Using the Tax Cuts and Jobs Act (TCJA) of 2017 as a natural experiment, we analyze changes in loan terms for firms facing higher after-tax borrowing costs due to limits on interest deductibility. We find that borrowers most likely to face limited interest deductibility negotiate lower interest rates post-TCJA. Importantly, we observe no changes in non-price terms such as covenants, maturities, or collateral requirements, suggesting that lenders bear a portion of the incidence of tax policy burdens with borrowers rather than offsetting reduced rates through stricter loan terms.  We also find no evidence of changes in the creditworthiness of firms with limited interested deductibility post-TCJA, suggesting that the change in loan spreads is not attributable to changes in borrower fundamentals. Our findings demonstrate lenders' willingness to bear borrowers' tax burdens as a novel channel by which tax policy affects corporate financing decisions and credit markets.  

Keywords: private lending, taxes, banking relationships, debt financing