AAA Spark Meeting of Regions

The Governance Role of Lender Monitoring: Evidence from Borrowers’ Tax Planning

• In Event: Taxation: Coppin State Volunteer Program, Firm Valud and Foreign Cash Holdings.

Abstract

This paper investigates the governance role of banks by examining lenders’ monitoring effect on borrowers’ tax planning. We posit that lenders’ monitoring has an impact on borrowers’ tax planning behavior on the two ends of the continuum of tax planning strategies. We show that firms with a larger portion of loan shares held by lead lenders, with loans led by reputable lenders and with a single-lending relationship have lower effective tax rates and less egregious tax aggressiveness. We also document that borrowing firms that experience loan sales that weakens lenders’ monitoring incentives tend to have higher effective tax rates and more egregious tax aggressiveness. Our results remain robust after addressing the potential endogenous concerns. Moreover, our results on egregious tax aggressiveness are stronger for firms with more intense shareholder-debtholder conflict (i.e., firms with higher R&D expenses and multinational firms). Overall, our findings suggest that lender monitoring reduces borrowers’ moral hazard through promoting legal tax planning but restricting egregious tax avoidance strategies.

Authors

• Fuzhao Zhou, State University of New York College at Brockport

• Jianning Huang, St Francis Xavier University