Financial market development and firm investment in tax avoidance: Evidence from credit default swap market

Authors

Hyun A. Hong
Gerald J. Lobo
Ji Woo Ryou, The University of Texas Rio Grande Valley

Document Type

Article

Publication Date

10-2019

Abstract

Lenders reduce their monitoring efforts after hedging their credit risk exposure through credit default swap (CDS) contracts, which are akin to insurance against borrowers’ adverse credit events. In this study, we examine whether, upon observing the reduced lender monitoring following CDS trading, shareholders demand that borrowing firms invest in more aggressive tax planning strategies, which were previously constrained by risk-averse lenders. Using a difference-in-differences design that exploits the variation in timing of the inception of CDS trading, we document that borrowers exhibit greater tax avoidance after the inception of CDS trading. Consistent with shareholders stepping up their demands post-CDS, we find that the increase in tax avoidance is stronger for (i) firms with more powerful and influential shareholders, as measured by dedicated institutional investors, (ii) firms with stronger shareholder defenders, as measured by board independence and board size, and (iii) firms with more strategic default options. We also find that borrowers with higher levels of tax avoidance are less likely to file for bankruptcy in the future. Our findings are robust to a battery of sensitivity checks, including controlling for cost of debt and endogeneity, as well as using alternative measures of tax avoidance.

Comments

© 2019 Published by Elsevier B.V. Original published version available at https://doi.org/10.1016/j.jbankfin.2019.105608

Recommended Citation

A. Hong, H., Lobo, G. J., & Ryou, J. W. (2019). Financial market development and firm investment in tax avoidance: Evidence from credit default swap market. Journal of Banking & Finance, 107, 105608. https://doi.org/10.1016/j.jbankfin.2019.105608

Creative Commons License

This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.

Publication Title

Journal of Banking & Finance

DOI

10.1016/j.jbankfin.2019.105608