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Tax avoidance and underleverage puzzle: Korean evidence

  • Youngdeok Lim

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    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. Copyright Springer Science+Business Media, LLC 2012

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    File URL: http://hdl.handle.net/10.1007/s11156-011-0258-8
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    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 39 (2012)
    Issue (Month): 3 (October)
    Pages: 333-360

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    Handle: RePEc:kap:rqfnac:v:39:y:2012:i:3:p:333-360
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    1. Desai, Mihir A. & Dyck, Alexander & Zingales, Luigi, 2007. "Theft and taxes," Journal of Financial Economics, Elsevier, vol. 84(3), pages 591-623, June.
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    16. Pittman, Jeffrey A. & Fortin, Steve, 2004. "Auditor choice and the cost of debt capital for newly public firms," Journal of Accounting and Economics, Elsevier, vol. 37(1), pages 113-136, February.
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