Daniel Saavedra

The Taxman Cometh: Does Tax Uncertainty Affect Corporate Cash Holdings?

We examine whether firms hold more cash in the face of tax uncertainty. Because of gray areas in the tax law and aggressive tax avoidance, the total amount of tax that a firm will pay is uncertain at the time it files its returns. The tax authorities can challenge and disallow the firm’s tax positions, demanding additional cash tax payments. We hypothesize that firms facing greater tax uncertainty hold cash to satisfy these potential future demands. We find that both domestic firms and multinational firms hold larger cash balances when subject to greater tax uncertainty. In terms of economic significance, we find that the effect of tax uncertainty on cash holdings is comparable to that of repatriation taxes. Our evidence adds to knowledge about the real effects of tax avoidance and provides a tax-based precautionary explanation for why there is such wide variation in cash holdings across firms.

Financial Reporting Regulation and Financing Decisions

We study the influence of a major reform in financial reporting regulation - the adoption of the International Financial Reporting Standards (IFRS) - on financial decisions around the world. Using IFRS as a setting with exogenous variation in information asymmetry, and relying on a pecking order theory framework, we test whether post-IFRS firms: (i) will be more likely to seek external (as opposed to internal) financing and (ii) conditional on raising external capital, will be relatively more likely to issue equity than debt. Further, we also study changes in financing choices conditional on financial distress. Our findings highlight the importance of disclosure regulation in explaining financing policies around the world.We study the influence of a major reform in financial reporting regulation on financing and capital structure decisions. Across a battery of tests, we document an increase in the issuance of external financing around the new regulation. Further, firms make different leverage decisions around the new regulation depending on their ex-ante debt capacity, and use their access to external financing to rebalance their capital structure. Our results are accentuated across firms facing higher adverse selection costs and in countries with stronger institutions. Our findings highlight the importance of financial reporting regulation in explaining financing as well as capital structure policies and provide insights into which firms are more likely to benefit from it.

Analysis of Unsuccessful Tax Avoiders

A longstanding question is why an important fraction of public companies pay relatively large amounts in taxes, apparently forgoing the benefits of tax avoidance. This study finds that firms with high effective tax rates are, to some extent, unsuccessful tax avoiders. These firms engage in tax avoidance activities but later return part of their tax savings to tax authorities. Moreover, lenders penalize these firms with higher loan spreads and more restrictive contract terms. This effect is economically important and represents a cost of engaging in tax avoidance activities. Overall, this study contributes to our understanding of corporate tax behavior by presenting the first study that analyzes unsuccessful tax avoiders.

The taxman cometh: Does tax uncertainty affect corporate cash holdings?

We examine whether firms hold more cash in the face of tax uncertainty. Because of gray areas in the tax law and aggressive tax avoidance, the total amount of tax that a firm will pay is uncertain at the time it files its returns. The tax authorities can challenge and disallow the firm’s tax positions, demanding additional cash tax payments. We hypothesize that firms facing greater tax uncertainty hold cash to satisfy these potential future demands. We find that both domestic firms and multinational firms hold larger cash balances when subject to greater tax uncertainty. In terms of economic significance, we find that the effect of tax uncertainty on cash holdings is comparable to that of repatriation taxes. Our evidence adds to knowledge about the real effects of tax avoidance and provides a tax-based precautionary explanation for why there is such wide variation in cash holdings across firms.

Renegotiation and the Choice of Covenants in Debt Contracts

I investigate whether and how expected future contract renegotiation considerations affect the type of covenants used in ex-ante debt contracts. Using an instrumental variables methodology, I find that when future contract renegotiation costs are expected to be high, debt contracts are less likely to include covenants that restrict the borrower’s financial flexibility. This finding suggests that, when renegotiation costs are high, borrowers and lenders avoid the use of covenants that are more likely to hold up the borrower and force her/him to bypass value-enhancing corporate policies (e.g., investments or the rebalancing of the firm’s capital structure). Consistent with this interpretation, the negative relationship between renegotiation costs and the presence of flexibility-reducing covenants becomes stronger when the borrower has fewer outside options and financial flexibility becomes more valuable. Overall, this study contributes to our understanding of how (1) renegotiation considerations affect the design of debt contracts and (2) covenants are chosen to mitigate renegotiation frictions.

The Information Content of Forgoing Tax Refunds: Evidence from Private Debt Contracts

A puzzle is why a large proportion of firms eligible for income tax refunds do not file claims for such refunds on a timely basis. I hypothesize that firms with private information about higher future profitability and seeking debt financing forgo immediate use of provisions that allow the carryback of net operating losses as a signaling device to separate from firms with lower future profitability in order to obtain more favorable borrowing terms. Firms expecting lower profitability are deterred from mimicking because carrying net operating losses forward is less valuable to them. Consistent with this hypothesis, firms that do not file claims for refunds on a timely basis display higher future profitability and receive lower debt financing costs than firms that file when they first become eligible. These results are stronger when the level of information asymmetry about the borrower’s type is greater. This study is the first to offer a rational explanation for the low take-up rate of tax refunds. As a result, the evidence presented in this study could be relevant to academics and fiscal policy makers that seek to better understand how tax policies affect real decisions.A puzzle is why a large proportion of firms eligible for income tax refunds do not file claims for such refunds on a timely basis. I hypothesize that firms with private information about higher future profitability and seeking debt financing forgo immediate use of provisions that allow the carryback of net operating losses as a signaling device to separate from firms with lower future profitability in order to obtain more favorable borrowing terms. Firms expecting lower profitability are deterred from mimicking because carrying net operating losses forward is less valuable to them. Consistent with this hypothesis, firms that do not file claims for refunds on a timely basis display higher future profitability and receive lower debt financing costs than firms that file when they first become eligible. These results are stronger when the level of information asymmetry about the borrower’s type is greater. This study is the first to offer a rational explanation for the low take-up rate of tax refunds. As a result, the evidence presented in this study could be relevant to academics and fiscal policy makers that seek to better understand how tax policies affect real decisions. This Draft: February 2016