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Review of Quantitative Finance and Accounting

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13.09.2021 | Original Research

Book-tax differences, CEO overconfidence, and bank loan contracting

verfasst von: Audrey Hsu, Cheng-Few Lee, Sophia Liu

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 2/2022

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Abstract

We assess information embedded in the difference between the reported book income and the taxable income (the book-tax difference, BTD hereafter) from the debtholders’ point of view. Using bank loan contracts of the U.S. publicly traded companies over years 2001–2017, we find that firms with larger book-tax differences pay higher interest for bank loans than do firms with smaller book-tax differences. Moreover, we find that banks reduce the use of financial covenants while increasing the use of general covenants for borrowers that have larger book-tax differences. In addition, banks are more likely to shorten loan maturity and require their loans to be collateralized for borrowers with larger book-tax differences. Furthermore, we find that the effects of BTDs on loan contracting are stronger if the CEOs of the borrowers are overconfident. Taken together, our findings suggest that larger book-tax differences increase a bank’s concerns regarding a borrower’s information risk and default risk. Thus, banks tend to take price and non-price protection against borrowers which have large BTDs.

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The information is identified from Refinitiv Global Syndicated Loans Reviews of 2019 Q4.

Non-financial affirmative covenants state what actions the borrower must take to be in compliance with the terms of the loan, such as paying the interest and fees, providing audited financial statements, etc. Non-financial negative covenants limit the borrowers’ activities, such as asset liquidity, excessive dividend payout, new debt issuance, etc.

Calls for eliminating differences between accounting income and taxable income in the U.S. have been debated extensively. Corporations’ incurring less compliance cost because they would report (essentially) the conforming number to both the IRS and the SEC; proponents of increased book-tax conformity argue that increased book-tax conformity may improve financial reporting and curtail aggressive tax planning. For example, Kuo and Lee (2016) find that country-level book-tax conformity is negatively associated with audit fees, consistent with the notion that increased book-tax conformity can simplify tax accruals and increase tax authorities’ monitoring, which reduces audit workload and audit risk, respectively.

As Desai and Dharmapala (2006) point out, the inference is qualitative similar using the residual from a regression of the Manzon-Plesko (2002) book-tax difference on the discretionary accruals.

We also use CEOHOLD67, an indicator variable which is set to one if a CEO postpones the exercise of vested options that are 67% in the money at least twice during the sample period, and zero otherwise as the robustness check and the untabulated results are consistent with our main findings following prior studies (Huang et al. 2016; Hsieh et al. 2014).

In additional analyses, our results are robust if we define Prior_Relation to be one if at least two (three) of the lead arrangers had been a lead arranger of the borrower’s previous loans over the five-year period preceding the loan’s issuance date and zero otherwise.

The untabulated results are qualitatively the same when LEV includes both short-term and long-term debts.

We also use the three-year duration to construct earnings volatility and cash-flow volatility and the results are qualitatively same.

Discretionary accruals are derived from the modified Jones model including lagged ROA as an additional repressor.

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Titel: Book-tax differences, CEO overconfidence, and bank loan contracting
verfasst von: Audrey Hsu
Cheng-Few Lee
Sophia Liu
Publikationsdatum: 13.09.2021
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 2/2022
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-021-00992-3

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