Abstract
This study investigates the relation between tax avoidance and the cost of debt capital and analyzes the effect of the debt ratio and profitability on the relation between tax avoidance and the cost of debt. The results of our empirical analysis are as follows. First, tax avoidance is significantly positively associated with the cost of debt capital. This result shows that tax avoidance is considered as the signal of increasing information risk; thus, investors demand a higher return. Second, the debt ratio decreases the positive relation between tax avoidance and the cost of debt capital. This result indicates that the positive relation between tax avoidance and the cost of debt capital significantly decreases when the debt ratio is high. Finally, we find that the profitability of a company increases the positive relation between tax avoidance and the cost of debt capital. This result means that the cost of debt capital increases as the tax avoidance increase when the profitability of company is favorable. We find that the profitability of a company is one of the critical factors that have an effect on the relation between tax avoidance and the cost of debt capital.
Highlights
Tax avoidance generally means that a company minimizes its tax burden within the law
This study investigates the relation between tax avoidance and cost of debt capital and analyzes the effect of company’s financial characteristics on the relation between tax avoidance and cost of debt capital
The debt ratio decreases the positive relation between tax avoidance and the cost of debt capital
Summary
Tax avoidance generally means that a company minimizes its tax burden within the law. Most previous studies use the estimate suggested by Desai and Dharmapala (2006) as the proxy of tax avoidance. This estimate assumes that tax avoidance is produced by book-tax difference. The implication of this study is to provide empirical evidence for the relation between tax avoidance and the cost of debt capital and to suggest evidence for the effect of company’s financial characteristics on the relation between tax avoidance and the cost of debt. For a company that avoids tax cost, investors demand high returns because the quality of the accounting information is poor, and investors estimate the risk of such companies as high. Creditors demand high returns because of the poor quality of the accounting information and the non-tax costs of tax avoidance. The fifth section outlines our empirical results and is followed by the conclusion
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