Credit Rating Conservatism and Corporate Tax Avoidance: Evidence from the Dodd-Frank Act As a Quasi-Natural Experiment

Abstract

Using the passage of Dodd-Frank as a quasi-natural experiment, we examine the effect of credit rating conservatism on corporate tax avoidance. We find that treatment firms engage in more tax-planning activities following Dodd-Frank than control firms. The results are robust to an alternative identification strategy based on U.S. sovereign downgrade. We further find that these effects are mainly driven by firms experiencing an increase in rating conservatism, firms with large existing tax-planning capacity, firms with decreased use of external financing, and firms with weak external monitoring. Overall, the findings provide evidence that credit rating conservatism plays an important role in corporate tax-avoidance decisions.