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This paper investigates the incremental effects of Form 10-K qualitative tax-related risk factor disclosures on the prices of syndicated loans. I find that firms with extensive tax-related risk factor disclosures enjoy lower loan spreads, controlling for the historical level of tax avoidance and tax risk. Further, I document that extensive tax-related risk disclosures attenuate the association between tax risk and the cost of debt. Overall, my findings are consistent with the premise that tax-related risk disclosures enhance management credibility and provide greater assurance to lenders. Thus managers can provide extensive tax-related risk disclosures to mitigate the debt premium associated with tax risk.
Keywords: tax risk disclosures, cost of debt, tax avoidance, tax risk, risk management
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INTRODUCTION
Recent research documents that tax risk factor disclosures reflect equity value-increasing tax planning activities (Campbell et al. 2019). The reported evidence indicates that tax risk disclosures provide information about the firm's future cash flows and equity investors view those disclosures positively, evidenced by higher stock returns. However, the effects on private lenders could be different because of their asymmetric payoff structure and their access to private information (Merton 1974). On the one hand, extensive tax-related risk disclosures could increase the salience of risks associated with tax avoidance to debtholders. On the other hand, extensive tax-related disclosures could mitigate the perceived tax risks to debtholders by conveying information about the firm's effective tax risk management practices. This study investigates whether tax risk disclosures are associated with the cost of debt in the context of syndicated loans. Syndicated loans account for more than half of total U.S. corporate financing (Sufi 2007, 2009).1 Given the great magnitude of private lending, managers have incentives to reduce debt financing costs that increase with tax risks (Hasan et al. 2014; Shevlin et al. 2019; Saavedra 2019).
I collect data on a sample of syndicated loans that originated in the U.S. between 2006 and 2017 from Loan Pricing Corporation's DealScan and match it to firm-year data obtained from Compustat and textual analysis of Form 10-Ks. Following prior literature related to tax avoidance and the cost of debt (Hasan et al. 2014; Shevlin et al. 2019; Saavedra 2019), I perform my analysis at the loan-facility level because a firm can obtain...