Beauty is in the eye of the beholder: The effect of corporate tax avoidance on the cost of bank loans

Abstract

We find that firms with greater tax avoidance incur higher spreads when obtaining bank loans. This finding is robust in a battery of sensitivity analyses and in two quasi-experimental settings including the implementation of Financial Accounting Standards Board Interpretation No. 48 and the revelation of past tax sheltering activity. Firms with greater tax avoidance also incur more stringent non-price loan terms, incur higher at-issue bond spreads, and prefer bank loans over public bonds when obtaining debt financing. Overall, these findings indicate that banks perceive tax avoidance as engendering significant risks.

Social Capital and Debt Contracting: Evidence from Bank Loans and Public Bonds

“…Table 3 indicates that an analogous increase in SOCIAL CAPITAL reduces bank loan spreads by approximately 4.33 bps. The finding that social capital has a greater incremental effect on bond yields than on bank loan spreads is consistent with Bharath et al (2008) and Hasan et al (2014), who find that bond investors are significantly more sensitive than banks in pricing risks into interest spreads. More importantly, they corroborate the argument that public bond holders perceive social capital as providing environmental pressure constraining opportunistic firm behaviors in debt contracting; consequently, they impose lower at-issue bond spreads when lending to firms with headquarters located in counties with higher levels of social capital.…”

“…There is substantial evidence that banks demand higher loan spreads in anticipation of the potential risks they face in debt contracting (Bharath, Sunder, and Sunder (2008), Graham, Li, and Qiu (2008), and Hasan et al (2014)). Accordingly, if banks perceive social capital as providing environmental pressure that constrains moral hazards in debt contracting, we expect that banks demand lower loan spreads when lending to firms located in communities with higher levels of social capital.…”

“…Bharath et al (2008) find that firms with poor accounting quality have higher bank loan costs. Hasan et al (2014) show that banks charge higher loan spreads when lending to firms that are aggressive in avoiding corporate taxes.…”

“…Section II.B discusses both of these effects. capital measure; after we control for the effects arising from local religiosity (Cai and Shi (2014), Jiang et al (2014)), corporate social responsibility (Goss and Roberts (2011)), and corporate tax avoidance (Hasan, Hoi, Wu, and Zhang (2014)); and when we use an instrumental-variable 2-stage regression analysis to address the endogeneity of social capital due to omitted variables that are potentially correlated with social capital and bank loan cost.…”

General Counsel Prominence and Corporate Tax Policy

“…Chen, X. Chen, Cheng, and Shevlin 2010;McGuire, Omer, and Wang 2012;Cheng, Huang, Li, and Stanfield 2012;Graham, Hanlon, Shevlin, and Shroff 2014), and the consequences of tax outcomes (Desai and Dharmapala 2009;Hanlon and Slemrod 2009;Graham and Tucker 2006;Kim, Li, and Zhang 2011;Jennings, Weaver, and Mayew 2012;Hasan, Hoi, Wu, and Zhang 2014). Our study contributes to the emerging stream of research investigating the influence of individual executives on corporate tax policy (Dyreng et al 2010;Armstrong et al 2012;Graham et al 2014) and, given the unique expertise and skill set of GCs, we answer a specific call in Hanlon and Heitzman (2010) for research investigating the influence of the GC in tax decisions.…”