The Effect of Tax Avoidance on Capital Structure Choices

Abstract

ABSTRACTExisting studies find that tax avoidance affects the cost of debt and equity in different ways but does not examine the consequences of these associations. This study examines a direct and important implication of the effect of tax avoidance on the cost of debt and equity: capital structure choices. Using logit regressions, we find that tax avoidance is positively associated with the probability of issuing equity rather than debt. We use mediation (i.e., path) analyses to provide evidence that the effects of overall tax avoidance and risky tax avoidance on pre-corporate tax cost of equity and debt partially explain our main effects. For stronger identification, we exploit a plausibly exogenous Ninth Circuit decision to implement a difference-in-differences design. Finally, we find indirect evidence that managerial focus on GAAP effective tax rate to estimate the after-tax cost of debt (Graham, Hanlon, Shevlin, and Shroff 2017), partially explaining our main results.