Corporate Tax Aggressiveness and the Role of Debt

Abstract

In this paper we study the impact of leverage on tax aggressiveness. We develop a simple two-date, oneperiod model to capture the manager’s incentives to avoid income taxes to shelter and divert money from the taxable income. The model predicts a trade-off between the benefits of diversion and the increased risk of bankruptcy. Predictions from the model are tested on a panel of U.S. firms from 1986-2012. We find evidence of a negative relation between leverage and tax aggressiveness; additionally, we find that tax aggressiveness reduces firm value. We control for endogeneity by using changes in the U.S. Bankruptcy Code in 2005 as an exogenous shock.