How do tax risk factor disclosures affect the cost of debt?

Abstract

This study investigates the effects of qualitative tax risk disclosures on the pricing of syndicated loans. The tax risk factor disclosures represent management's qualitative assessments of firms' potential losses upon challenges by tax authorities. They may contain information incremental to the quantitative tax avoidance and tax volatility measures reported in the financial statements and tax returns lenders may obtain through private communication channels. I find that firms with more extensive tax risk disclosures enjoy lower loan spreads, suggesting that tax risk disclosures enhance information transparency not only between lenders and borrowers but also between lead arrangers and participants in loan syndicates. This effect is more pronounced for firms with lower quality information environments and higher IRS audit risk. I also find that tax risk disclosures signify management's ability to manage tax risks, which provides greater assurance to lenders, as evidenced by lower future tax volatility and lower contracting costs of tax avoidance. Overall, I provide empirical evidence on how tax risk disclosures affect the cost of debt in the syndicated loan market.