Corporate Tax Avoidance and Debt Policy

Abstract

This paper examines the relation between corporate tax avoidance and debt policy using a large sample of firms from 1988 to 2006. We use modified measures of book-tax difference and long-run cash effective tax rate to proxy for tax avoidance. Using both measures we find consistent evidence that tax avoidance is negatively associated with leverage ratio. Further, we find that the substitution of non-debt tax avoidance for debt dissipates for very large, highly profitable firms, and firms with higher credit rating. Our findings are robust to alternative measures of leverage. Consistent with the debt substitution hypothesis, we offer new evidence to show that tax is an important factor in corporate capital structure decisions.