Tax avoidance and underleverage puzzle: Korean evidence

Youngdeok Lim ()

Review of Quantitative Finance and Accounting, 2012, vol. 39, issue 3, 333-360

Abstract: This paper examines whether tax avoidance substitutes for the use of debt, as well as investigating the impact of the tax-exhaustion effect and the cost of debt in this relationship. Applying a modified version of the tax-avoidance measure in Desai and Dharmapala (Rev Econ Stat 91:537–546, 2006 ), I determine the marginal substitution effect of tax avoidance for the use of debt for a large sample of Korean firms, generalizing the evidence of Graham and Tucker (J Financ Econ 81:563–594, 2006 ). Furthermore, I find that the debt-substitution effect increases with the probability of losing tax shields, suggesting that the tax-exhaustion effect interacts with the debt-substitution effect. In addition, the debt-substitution effect becomes stronger when the cost of debt is high, indicating that the cost of debt is a determinant of the substitution effect. The debt-substitution effects of tax avoidance suggest that tax-avoidance activities could offer a partial explanation for the underleverage puzzle. Copyright Springer Science+Business Media, LLC 2012

Keywords: Tax avoidance; Underleverage puzzle; Debt-substitution; Tax-exhaustion; G32; H26 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11156-011-0258-8

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