اجتناب مالیاتی، هزینه بدهی و فعالیت سهامداران: شواهدی از کره

This paper examines the impact of tax avoidance on the cost of debt and its interaction effect with shareholder activism. Using Korean firms, I find a negative relationship between tax avoidance and the cost of debt, supporting the trade-off theory. Further tests reveal that the negative relationship becomes stronger when the level of institutional ownership is high. It becomes even stronger after 1998, when the shareholder rights of institutional investors were strengthened. It suggests that the managerial opportunism theory has an additional explanation for tax avoidance activities. My findings indicate that tax avoidance reduces the cost of debt through trade-offs and creates a managerial rent diversion, which is mitigated in firms with larger institutional holdings.

This paper investigates the impact of tax avoidance1 on the cost of debt and its interaction effect with shareholder activism in publicly-held firms. The Hyundai Automotive Group, a Korean chaebol (business group), faced allegations that it created massive slush funds through the unusual method of deflating its operating profits and inflating losses. In fraudulent accounting practices, the opposite—inflating profits and deflating losses to lure investors—is more common. As a result, a prosecution official stated, “We’re investigating to determine the overall scale of the slush funds the Hyundai Automotive Group established by adopting such accounting measures. If my probe into the group reveals that it did not pay taxes and used the money for business or lobbying purposes, it will face additional charges for tax evasion and appropriation of company funds in the conduct of business or bribery. Investigators are collecting mountains of evidence (Chosun Ilbo, 17 April 2006).” In response, the group announced that its chairman promised to donate $1.1 billion worth of personal assets to society and apologized for causing concerns to the public over the scandal. As a result, the chairman was sentenced to 3 years in prison for creating the large slush funds. The first objective of this paper is to investigate whether tax avoidance as a tax-favored activity reduces the cost of debt. The cost of the debt of a firm is determined by the characteristics of the firm and those of the bond issue that affect default risk, agency costs, and the information asymmetry problem (Bhojraj and Sengupta, 2003). Graham and Tucker, 2006 and Lim, 2010 suggest that tax-favored activities, such as tax shelters and tax avoidance, are a substitute for the use of debt. Graham and Tucker (2006) examine 44 tax shelter cases that were issued as a Notice of Deficiency by the Internal Revenue Services (IRS). These cases indicate that firms use less debt when they engage in tax sheltering. Using the tax avoidance measure modified from Desai and Dharmapala, 2006 and Lim, 2010 determines the existence of a substitution effect of tax avoidance for the use of debt for a large sample of Korean firms. These results were consistent with the results of Graham and Tucker (2006). If tax avoidance is a substitute for the use of debt (Graham and Tucker, 2006 and Lim, 2010), it could increase financial slack, reduce expected bankruptcy costs, enhance credit quality, lower default risk, and therefore reduce the cost of debt. This supports the trade-off hypothesis that the debt-substitution effect of tax avoidance would reduce the cost of debt, an issue not investigated in Graham and Tucker, 2006 and Lim, 2010. Second, this paper investigates managerial opportunism theory on the relationship between tax avoidance and cost of debt by examining the effect of shareholder activism on the relationship. From an agency perspective, tax avoidance would reduce the transparency of firms, and permit managers with the opportunity to extract rents from outside investors, creating a shield for managerial opportunism and the diversion of rents (Desai and Dharmapala, 2006, Desai et al., 2007, Desai and Dharmapala, 2009 and Wilson, 2009). Desai and Dharmapala, 2006 and Desai et al., 2007 argue that corporate tax sheltering and the diversion of rents by managers are interrelated and complementary. Desai and Dharmapala (2009) find that the average effect of tax avoidance on firm value was not significantly different from zero. However, it is found to be positive for well-governed firms, which indicates that a higher quality of corporate governance, measured as a higher level of institutional ownership, leads to a favorable effect of tax avoidance on firm value. Tax avoidance could cause agency conflicts between management and debtholders, since managerial rent diversions induce information asymmetry and create moral hazard problems. However, institutional investors possess greater incentives and capacity to monitor managerial performance (Shleifer and Vishny, 1986, Chung et al., 2002, Hartzell and Starks, 2003, Bhojraj and Sengupta, 2003 and Desai and Dharmapala, 2009).2 Thus, the higher the level of institutional ownership, the greater is the degree of scrutiny to which managerial actions are subjected, and the less important is the conflict of interests between the management and debtholders. Institutional investors could reduce the cost of debt by alleviating agency problems, thereby decreasing opportunities for the managerial rent diversion of tax avoidance. Using Korean firms, I examine the impact of tax avoidance on the cost of debt. I further investigate the effect of shareholder activism on the relationship between tax avoidance and the cost of debt. Shareholder activism was defined as a level of ownership by institutional investors (Desai and Dharmapala, 2009) and an exogenous variation of institutional investors in 1998 in Korea. For example, the Sovereign Asset Management Corporation,3 which emerged as the biggest shareholder of the SK Group, one of chaebols in Korea, stated that for the SK to recover, radical reforms were necessary. Sovereign stated that it planned to renovate the corporate governance of the SK to clean up the company, and added that it would work with the management team of SK to achieve such goals. Sovereign expressed the view that the SK must discontinue its old business practices and strive to regain shareholder and market trust, stating that “Investment in the SK will transform a corporate tragedy into a triumph of corporate governance.” I anticipate that institutional investors reduce the cost of debt by alleviating agency problems, thereby increasing the negative effect of tax avoidance on the cost of debt. Furthermore, I expect that the impact of institutional investors on tax avoidance and the cost of debt increased after 1998, when shareholder rights related to institutional investors, including foreign investors, were strengthened in Korea. I estimate the tax avoidance measure modified from Desai and Dharmapala (2006). My results indicate that there is a negative relationship between tax avoidance and the cost of debt for a large sample of Korean firms, supporting the trade-off hypothesis. Further tests reveal that the relationship becomes stronger when the ownership of institutional investors is high, becoming even stronger after 1998, indicating that managerial opportunism arguments have an additional explanation for tax avoidance. I find that the influence of shareholder activism on the negative relationship between tax avoidance and the cost of debt was greater when controlling for the other governance effects in 1998. These results are robust for a wide variety of tests, including the relationship between tax avoidance and firm value, changes in the tax rate, the decomposition of institutional investors, the additional control for the probability of bankruptcy, and alternative measures. My findings indicate that tax avoidance reduces the cost of debt through trade-offs and creates a managerial rent diversion, which is mitigated in firms with larger institutional holdings. Also, these suggest that bondholders view institutional investors as a monitoring vehicle that decreases the opportunities for managerial rent diversion by mitigating agency costs. Korea provides a good research setting for exploring these research questions in terms of five aspects. First, unlike in the US, taxable income data necessary to calculate the tax avoidance measure is directly available from annual reports and does not need to be estimated (Desai and Dharmapala, 2006). This reduces the measurement error of tax avoidance and provides a large sample of evidence. Second, traditionally, Korean firms have heavily relied on bank financing (Baek et al., 2004) and experienced the financial crisis that began in 1997. Since chaebols, such as the Daewoo Group, Kia Group, and Hanbo Group, went bankrupt, debtholders suffered from this process and became vulnerable to managerial malfeasance or diversions. Weak investor protection in Korea enabled controlling shareholders to expropriate other investors, including minority shareholders and debtholders. This caused debtholders to become interested in mitigating agency conflicts between controlling shareholders and debtholders through good corporate governance in Korea. Third, Korean corporate governance has characteristics that are particularly suitable to my research questions. In 1998, after the financial crisis, the Korean government reformed shareholder rights. This source of exogenous variation of institutional investors permits the investigation of the causal effect of institutional investors on tax avoidance and the cost of debt. Fourth, Korean companies were required to disclose their ownership in the annual report using standard types of security holders until 2003. These security holders include governments, government-related companies, security firms, insurance firms, banks, individual investors, and foreign investors. This makes it possible to decompose institutional investors and investigate the impact of the types of institutional investors on cost of debt (e.g., Elyasiani and Jia, 2010).4 Finally, the Korean government has shown interest in the increasing number of tax avoidance activities and has designed a policy to effectively prevent such activities in 2006, thereby making tax avoidance an appropriate issue to examine in Korea. This study makes the following contributions to the literature. First, this paper makes significant contribution to previous literature by investigating the relationship between tax avoidance and cost of debt and further applying the agency perspective to the relationship. To my knowledge, this is the first attempt to explicitly examine the impact of tax avoidance on the pricing of corporate debt, which also provides some insight into the bond market reaction to the substitution effect of tax avoidance for the use of debt ( Graham and Tucker, 2006 and Lim, 2010). Also, this paper considers agency costs for the analysis of corporate tax avoidance on the cost of debt and investigates whether institutional investors, as shareholder activists, alleviate managerial opportunism and affect the negative relationship between tax avoidance and the cost of debt. Desai and Dharmapala (2009) only test the agency perspective of corporate tax avoidance on firm value and Lim (2010) only tests the trade-off theory by using Korean evidence and show that tax avoidance is negatively associated with the use of debt. Second, this paper illustrates that improved shareholder activism leads to a lower cost of debt, implying that good corporate governance proxied by institutional ownership could reduce the cost of capital from the perspective of enterprise risk management. Even though a substantial amount of research addresses the relationship between corporate governance and firm value (e.g., Joh, 2003, Baek et al., 2004, Black et al., 2006 and Desai and Dharmapala, 2009), few studies have examined the relationship between corporate governance and the cost of debt. Daily et al. (2003) identify shareholder activism as an important factor in corporate governance, which has not received adequate attention in the extant literature. This study provides new evidence on the agency conflicts of controlling shareholders and debtholders. Finally, I improve upon the tax avoidance measure used in Desai and Dharmapala (2006). Unlike Desai and Dharmapala (2006), I use the discretionary accruals, rather than total accruals as an earnings management proxy and improve upon the accuracy of the tax avoidance estimation. I also provide evidence that tax avoidance comes from both temporary and permanent differences. The remainder of the paper is organized as follows. Section 2 develops the hypotheses. Section 3 describes the sample selection procedures. Section 4 specifies the regression variables used for testing the impact of tax avoidance and institutional ownership on the cost of debt. Section 5 presents the test methodology and results for the debt pricing tests, and Section 6 concludes the paper.

This paper examines whether participating in tax avoidance activities is negatively associated with the cost of debt (COD), and whether institutional investors, as shareholder activists, intensify the effect of tax avoidance on the COD. I use the tax avoidance measure modified from Desai and Dharmapala (2006), who decomposed the book-tax difference into earnings management and tax avoidance components. I find a negative relationship between tax avoidance and the COD for a large sample of Korean firms, supporting the trade-off theory. Further tests reveal that the negative relationship becomes stronger when institutional investor ownership is high; and even stronger after 1998, when the voting rights for institutional investors were reinstated. This suggests that the managerial opportunism theory further accounts for the tax avoidance. These results are robust for a wide variety of tests, including the relationship between tax avoidance and firm value, changes in tax rate, decomposition of institutional investors, additional control of probability of bankruptcy, and alternative measures. This suggests that bondholders view tax avoidance as tax savings that reduces the COD and institutional investors as a monitoring vehicle that decreases the opportunities for the rent diversion of tax avoidance by mitigating agency costs with controlling shareholders. This study contributes to a growing line of research on shareholder activism. In particular, the findings complement recent evidence in the US that suggests a greater influence of shareholder proposals and votes on corporate decisions in the post-SOX environment (Del Guercio et al., 2008 and Ferri and Sandino, 2009). This study also has a policy implication, i.e., that debtholders favorably view shareholder activism that decreases opportunism for the managerial rent diversion at an early stage in an emerging market given the increasing active role of institutional investors. In addition, strengthening the role of institutional investors is found to be beneficial to lower the cost of capital for poorly-governed firms.