Tax Avoidance and Cost of Debt : The Case for Loan-specific Risk Mitigation and Public Debt Financing

Examining the syndicate loans market for publicly traded U.S. firms I show that tax avoidance is positively related to loan spreads. Importantly, however, I document that the positive link between tax avoidance and loan spreads is largely eliminated for loans with effective risk mitigating mechanisms. In particular, tax-specific premiums disappear when lenders either contractually align borrowers' interests with theirs' via performance-sensitive provisions, diversify away loan-specific risks via lead syndicate formation or transfer loan-specific risks back to the financial system via credit default swap contracts. Moreover, tax risk is not priced in for loans with significant institutional investor participation. Finally, I show that simultaneous access to private and public debt financing, which reflects greater firm-level financial flexibility and fewer hold-up problems, largely mitigates agency risks associated with all forms of tax avoidance. These syndicate-level risk-mitigating measures work jointly well and are more effective, ex-ante, at moderating tax-specific risks in comparison to covenant-based monitoring structures alone. These results help identify channels through which firms can mitigate non-tax costs associated with tax avoidance and hence, effectively pursue strategies that persistently reduce their corporate tax burden without incurring material agency costs