Do Creditors Actively Influence Corporate Tax Planning? Evidence from Loan Covenants

Abstract

Recent literature suggests that creditor intervention following covenant violations mitigates managerial agency problems and plays an important governance role (e.g., Nini, Smith, and Sufi, 2012). This study examines how heightened creditor governance after covenant violations affects corporate tax avoidance decisions. Using a regression discontinuity design, we find that creditor intervention increases borrowers’ tax avoidance in the less aggressive forms. This effect is concentrated among firms under weaker shareholder governance before creditor intervention and among those having lesser bargaining power during subsequent debt renegotiation. Our results indicate that creditors play an active role in shaping corporate tax policy outside of bankruptcy.