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Economic Implications of Tax Risk: Evidence from Debt Contracts

Sat, April 27, 10:25 to 11:40am, Hyatt Fisherman's Wharf, TBA

Abstract

A potential drawback of aggressive tax strategies is that tax authorities can deem them non-compliant and ask tax avoiders to pay back taxes and penalties. This study tests whether these realizations of tax risk have additional economic consequences in the lending market. In particular, I investigate whether lenders in the syndicated loan market assess tax avoiders differently when these have made large payments to tax authorities in the past. My findings suggest that lenders charge this type of tax avoider higher interest rates. In contrast, tax avoiders not exposed to this risk are offered lower interest rates. This result is consistent with lenders price protecting against borrowers that are more likely to experience a tax motivated deterioration of their credit quality. Moreover, I find that this result is mostly driven by borrowers that have not developed a strong reputation and which are less known to the lending community. As a result, the degree of information asymmetry between the borrower and the lender affects how banks assess tax avoiders that have experienced realizations of tax risk. Finally, the data suggests persistence in the exposure to tax risk: firms that experienced material realizations of tax risk in the past are also more likely to make large tax payments in the future. Overall, this study contributes to the literature by providing evidence that risk associated with tax avoidance can have financial effects beyond payments to tax authorities.

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