Debt and Corporate Tax Evasion

Shareholder wealth may be maximized by borrowing, as it is tax preferred, or by under reporting firm profits; both shield income from taxation, legally in the case of the former. But does the utilization of one shield crowd out the use of the other? More specifically, does tax evasion lead to lower leverage, as the empirical literature suggests, or is it the other way around with highly leveraged firms cheating less? Using a unique random sample of small corporations thoroughly audited, the empirical results show that tax evasion declines with firm leverage; there is little support for the findings in the literature