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Review of Quantitative Finance and Accounting

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01.10.2012 | Original Research

Tax avoidance and underleverage puzzle: Korean evidence

verfasst von: Youngdeok Lim

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2012

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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.

Vorheriger Artikel Alternative statistical distributions for estimating value-at-risk: theory and evidence

Nächster Artikel An agency-based perspective on the performance consequences of COO adoption

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Tax avoidance conceptually includes the transactions undertaken to minimize tax liabilities, including general tax reduction methods and tax shelters that are occasionally of questionable legality (Desai and Dharmapala 2006; Hanlon and Heitzman 2010). In Sect. 4.1, I discuss the definition and measurement of tax avoidance.

Taxable income data was obtained from the note of financial statements that are audited by external auditors in the Korean electronic disclosure system (http://www.dart.fss.or.kr) of the Financial Supervisory Service. To my knowledge, there is no other country that provides taxable income data in the note of financial statements that are audited by external auditors. This suggests the superiority of Korean accounting data.

The National Tax Service and the Korea Institute of Public Finance published the report, “The Cases of ATP (aggressive tax planning) and Preventive measures” in 2006. In the same year, the Board of Audit and Inspection of Korea published the report, “The Reality of Managing International Tax Resources,” which investigated tax-avoidance cases using the tax treaty (convention for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and capital).

Graham (2000) measured the kink for debt conservatism as the maximum amount of interest deductions a firm could make before any decline in the marginal tax benefit of debt relative to the actual interest charges the firm incurred, given its current debt.

The KIS value database is provided by Korea Investors Service, Inc., which is affiliated with Moody’s.

Since I include the Lag5(debt/asset) as a control variable in the model specification, the total sample in the balanced panel should have data from 1995 to 2006.

I do not truncate the outliers outside the 5th or 95th percentiles of the pooled distribution, as Pittman and Fortin (2004) did, since the sample selection procedures reduced the outlier effects.

I discuss the characteristics of the tax avoidance I measure in Sect. 5.2.

Since I exclude the earnings management component, measured as discretionary accruals in BTD, the tax avoidance measure could be more accurate than the tax spread of Schallheim and Wells (2006) and the tax avoidance of Desai and Dharmapala (2006).

I truncated the firms whose ETRs are negative or greater than one.

Under Korean tax law, some investment tax credits as a part of NDTS are deductible below the taxable income, indicating that Dep does not fully cover the investment tax credits. Thus, I introduce tax-aggressiveness (TAXAG) to capture the tax subsidies, and present the test results in Sect. 5.6.3.

Following Lopez et al. (1998), I measure tax aggressiveness (TAXAG) as an alternative tax avoidance proxy. Sect. 5.6.3 provides the definition of TAXAG and the test results.

I made subsamples that have a positive BTD and negative BTD and tested all the hypotheses. I added Sect. 5.6.1. Positive versus Negative BTD to compare the findings.

I checked the estimate of tax avoidance and leverages for the 3 affiliated firms in Hyundai Automotive Group (Hyundai Motors, Kia Motors and Hyundai Mobis) and found that both book and market leverages decreased from 2000 to 2006, whereas tax avoidance activities (TA_mod, TA_per and TAXAG) increased for the same period for all three firms.

The high correlations among debt/asset, Lag5(debt/asset), and COD are likely to cause multicollinearity problems. For all regressions, I checked for the multicollinearity problem using variance inflation factors (VIF).

The F-test rejects the null hypothesis that there are no fixed effects. Hausman tests confirm that the fixed effects model is the appropriate design for examining all hypotheses.

I define firms in the lower 25% of the effective tax rate distribution as firms with a high probability of losing the deductibility of tax shields and firms in the upper 75% of the effective tax rate distribution as firms with a low probability of losing the deductibility of tax shields. The results are consistent with the results using the median as the cutoff.

Rajan and Zingales (1995) used both the book and market leverage measures of capital structure and found that they provide similar results in the cross-sectional analysis.

The unreported results that measure TA_per as tax avoidance are almost identical with the results in Table 9.

I also used an indicator variable for tax aggressiveness that takes one for the sample above the median TAXAG, and 0 otherwise, and found robust evidence.

The unreported results using TA_per as a tax avoidance proxy are almost identical with the results in Table 10.

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Titel: Tax avoidance and underleverage puzzle: Korean evidence
verfasst von: Youngdeok Lim
Publikationsdatum: 01.10.2012
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2012
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-011-0258-8

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