Discuss About The Forecast Properties Information Environment.
The chosen topic for assessment of literature review is “how tax avoidance activities affect corporate bankruptcy risks”. Analysis of relationship is done by reviewing ten journal articles selected from relevant sources that would depict different views of different authors. There have been number of studies that deal with the avoidance of tax activities and tax planning with the corporate bankruptcy risks. The literature on corporate tax avoidance in this regard does not come with any study that explicitly examines the relationship between cost of debt and tax avoidance and ultimately to bankruptcy risk that further leads to the application of agency perspective to the relationship. Since more than third of profit of firms are taken away by government through taxes, it is quite understandable about the incentive to avoid paying taxes. The bankruptcy risk of firms can be increased if the capital structure involves more proportion of debts compared to equity and make investment in assets generating riskier cash flow (Al?Hadi et al. 2017). Therefore, it is required to empirically as well as theoretically examine the level of sheltering the firms to default probability and debt level in its capital structure for assessing the impacts of these two bankruptcy risks aspects.
The main objective of report is to ascertain and identify the relationship between tax avoidance activities of firms to their corporate bankruptcy risks. Identification of relationship is done critically reviewing ten journal articles from different relevant sources for supporting the arguments presented by different authors. Furthermore, the objective of report is compare and contrast views of different authors on the concerned topic.
The findings generated from research paper on the given topic helps in adding to literature by highlighting importance of different parameters in establishing relationship between tax planning or avoidance and corporate bankruptcy risks. Empirical findings generated from one research paper provides strong evidence of negative relationship between leverage and tax sheltering that is considered importance for high risk firms. Tax avoidance can be looked in terms of both benefits and costs to company (Business.unsw.edu.au 2018). Current cash flow of organization is increased when company avoids tax payment and this would have positive expected value for firms. On other hand, tax position of firms will be challenged that results in higher future payment of penalties and tax and thereby making tax position risky and firms at bankruptcy risk. Other research paper comes with findings that increase in level of tax avoidance, there is increase in level of financial constraints and this increases level of firm cash savings (Erepository.uonbi.ac.ke 2018).
This particular section of report illustrates findings from several journal articles extracted from different sources. Views of authors are supported by presentation of logical arguments that helps in explaining the relationship between corporate bankruptcy risk and tax avoidance. An article extracted from sciencedirect,com published on July, 2014 named “ The effect of corporate tax avoidance on bank loan costs” depicts that firms with greater tax avoidance have to incur high spreads when they require loans from bank (Jalan 2016). It is perceived by lenders such as banks tax avoidance engenders significant risks.
Another article extracted from sciencedirect.com on corporate tax aggression and debt provide a trade off model of capital structure that consider leverage to be a function of choice of firm of tax aggressiveness. Implications of model are tested empirically and the relationship between corporate tax aggression and debt use is considered economically important. It has been found that for most of the firms, debt use is inversely related to corporate tax aggression. Firms that have scored higher prediction score of tax shelter exhibit that substitution effect is evident of the fact of such relationship. Tax aggression and debts are considered complements for the most profitable firms (Kubick et al. 2016).
A paper on debt, corporate tax aggressiveness and bankruptcy extracted from finance group of a business school. The theory used in the analysis predicted that there is inverse relationship between tax sheltering and bankruptcy cost of managers and leverage. Results of empirical test are consistent with theoretical predictions. Tax sheltering has been found to be negatively related to bankruptcy risk and leverage and for riskier firms, such negative effects of debt and bankruptcy risks are stronger. The findings are opposite for weaker firms as the negative effects between such variables are not strong. In order to depict that findings of research paper are robust to endogeneity concerns, authors have used two changes to bankruptcy law (Nesbitt et al. 2017).
A paper on role of debt and corporate tax aggressiveness intended to study the impact of leverage on tax aggressiveness. Study was conducted with the development of simple two date and one period model for capturing incentives of managers to avoid income tax sheltering and money diversion from taxable income. Evidences have been found that depicted negative relationship between tax aggressiveness and leverage. The developed single period model is based on intuition that bankruptcy is costly for managers (Akamah et al. 2016).
According to Richardson et al. (2014), the examination of relationship between tax avoidance and equity incentive to managers depicts that higher incentive compensation reduces tax avoidance. On other hand, it has been found by Isin (2018), that tax aggressiveness and equity risk incentives have a positive association between tax aggressiveness and equity risk incentives. However, corporate governance at firm level does not influence such relationship.
In a research paper, extracted from parsproje.com on maturity structure of debt and corporate tax aggressiveness that investigated the association between corporate debt maturity and tax aggressiveness. It was found that tax aggressive firms have shorter debt maturity and tax aggressiveness is viewed as risky activity by lenders and this restricts the debt maturity structure of debt providing monitoring mechanism for debt contracts with borrowers who are tax aggressive (Crane and Matten 2016).
One of the articles named reviewing research on leverage puzzle and corporate tax aggressiveness extracted from the journal of Australian tax research association. In this article, previous research was reviewed on relationship between leverage and corporate tax aggressiveness depicts that puzzle remained unsolved. Engagement of firms to avoid taxation requires use of deductibility of debt interest and therefore high debt ratio is considered as part of tax aggressive schemes (Sbs.ox.ac.uk 2018). This makes it challenging to conclude that there is a casual relationship between leverage and tax aggressiveness. Moreover, it has been proposed in the table that companies that are successful in avoiding payment of taxation has the possibility of sustaining large difference between taxable income and book value. This in turn would lower the associated bankruptcy risks.
In an article extracted from onlinelibrary.wiley.com on “taxes and credit ratings-the effect of book tax differences on credit ratings of firms”. This paper is prepared for examining whether information contained in the taxable and credit analysts in analyzing the credit risks of firms utilize book income. An increase in book tax differences signals the changes in off balance sheet financing of firms, decreased quality of earnings, and are such changes are considered informative (Donohoe 2015). It has been found there is considerable negative association between any positive changes in book tax differences. Less favorable rating changes have been witnessed when there are large negative changes in book tax differences.
An article extracted from semanticsscholar.com that is about empirical analysis on debt policy and corporate tax aggressiveness. It has been found that there exists negative correlation between level of debt and tax aggressiveness. In addition to this, negative correlation has been observed proportion of outside directors on board and level of debt. For monitoring the management, corporate debt plays a consequential role and thereby helps in reducing agency costs. While examining the relationship between monitoring mechanism and debt level, it was found that there exists correlation between them; however, the nature of relationship is not clear (Graham et al. 2017).
One of the research papers on debt equity and taxation bias extracted from ec.europa.eu by Serena Fatica and Thommas hemmelgarn discusses the debt bias consequences in relation to taxation payment. It has been found that under most corporate income tax system, the tax deductibility interest payments do not have any measure to be foreseen for financing equity and this creates distortion in financing decision of organization. Corporate tax bias might lead to high degree of leverage in companies and thereby increasing systematic risks (Bayar et al. 2016).
The methodology used in analysis of relationship between debt, corporate tax aggressiveness and bankruptcy make use of simple framework. Such framework helps researcher in obtaining close form solution for presenting comparative statistics and optimal level of sheltering of firms. It has been assumed in this particular research paper that debt level is exogenous and it derives the levered firm optimal level of sheltering. A two stage least square methodology is used as the negative relations are regarded as robust for making adjustments for endogeneity. Negative relation has been found between bankruptcy risk and tax sheltering in cross sectional analysis (Richardson et al. 2014).
Methodology used in research paper for identifying relationship between debt maturity structure and corporate tax aggressiveness is about selection of samples and measurement of corporate tax aggressiveness. Sample used in the study is derived from the intersection of execucomp and compustat database through 2012 and the measure of tax aggressiveness is done by measuring the likelihood of tax sheltering. This is so because the most aggressive form of tax aggressiveness is captured by the likelihood of tax sheltering. Regression control used for the analysis purpose does not completely capture the activities of tax avoidance of firms. It has been found that shorter debt maturity is associated with higher tax avoidance level. The emerging streams of literature receive contribution from such results that helps in investigating the tax aggressiveness consequences. Results complement the work of Hasan et al. (2014) that lenders into loan spreads price the risk of tax aggressiveness and evidence is provided in supply favor forces in negative relationship between leverage and tax aggressiveness.
Research methodology involved in capital structure measurement, tax planning involves determining the panel of dataset, and the main sources of data collection were income statement and balance sheet of companies (Hsu et al. 2016). In this particular study, samples have been selected from companies listed on Malaysian stock exchange and the companies that do not have proper data are excluded from sample.
The empirical analysis of tax avoidance is considered highly challenging due to concealment of activities and perhaps social shame and threat of punishment makes companies unwilling to accurately respond to surveys conducted. Research work has exploded two research designs that is analysis of kinks and notches in policy and regression discontinuity (Efmaefm.org 2018).
Research methodology adopted in determination of firm value due to effects of tax planning of company involves formation of research design, data collection and sampling process. Secondary data for the analysis purpose were sourced from websites of company and it involved panel of data. Data collected were described using descriptive model in terms of standard deviations and mean scores. Results were interpreted by examining the level of tax planning of firms using median and mean values (Dhaene et al. 2017). Data analysis was performed using panel data regression techniques.
Gaps in literature review concerning with identification of relationship between bankruptcy risks and tax planning was ascertained in terms of lack of availability of data on tax avoidance or tax sheltering of companies that was selected in the sample. Moreover, there is no proper disclosure of the planning method of taxation of companies and appropriate and authentic data for the analysis was difficult to obtain. It made it difficult for researcher to create a proper linkage between corporate bankruptcy risk and tax avoidance and tax sheltering of companies (Faccio and Xu 2015).
Data gathered for the analysis of relationship between these two identified variables in research paper were extracted from two more sources. A number of methods are used by researchers for accounting the endogeneity concerns in examination of tax related effects (Hasan et al. 2014). Therefore, it is very essential to address the problem of endogeneity for studying the relationship between bankruptcy risk and tax aggressiveness. It is required to fill the gaps in literature by extracting the data from several other relevant sources and hence, it can be regarded that gap exist in terms of uniformity of data while conducting research. Furthermore, data gathered are searched from two or more than two sources might create skewed data in results of research paper (Chen et al. 2017). However, data are sourced from several sources for creation of data integrity.
Conclusion:
Identification of relationship between tax avoidance and bankruptcy risk has been a topic of research to academics in accounting, finance and taxation. From the analysis of research paper in identification of relationship between tax avoidance by organization and corporate bankruptcy risk, it can be inferred that there exist negative relationship bankruptcy risk or debt level and tax avoidance. Nevertheless, other relevant articles came with conflicting conclusion that corporate tax avoidance is associated positively with debt holdings. Second line of report gives a conclusion of negative association between leverage and tax aggressive activities. While some other studies and research paper shows insignificant and mixed findings in respect of leverage or bankruptcy risk and tax aggressive of firms. However, four main issues are suggested from literature review and it involves bi directional or casual relationship between bankruptcy risk associated with debt level of firms and tax avoidance, cost of debt level and measures of debt level, proxies used for engagement of firms in tax aggressive activities and endogeneity of corporate tax status. The contribution of empirical and theoretical results is to show that bankruptcy risks due to presence of debt in the capital structure is regarded as a crucial determinant of income sheltering and thereby reducing tax sheltering of corporations. It has also been highlighted by results that tax sheltering reduces the introduction of likelihood of bankruptcy by serving as monitoring mechanism.
The puzzle of leverage and tax aggressiveness are faced with a number of issues that requires further examination and explanation in future research. It is considered essential to determine the most relevant proposition having the dominant effect since arguments and competing theories supports positive and negative relations between bankruptcy risk and corporate tax avoidances. Attempt of future research might be to document the association between debt for each level of tax aggressiveness and tax avoidances.
References list:
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Al?Hadi, A., Chatterjee, B., Yaftian, A., Taylor, G. and Monzur Hasan, M., 2017. Corporate social responsibility performance, financial distress and firm life cycle: evidence from Australia. Accounting & Finance.
Bayar, O., Huseynov, F. and Sardarli, S., 2017. Corporate Governance, Tax Avoidance, and Financial Constraints. Financial Management.
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Dhaene, J., Hulle, C., Wuyts, G., Schoubben, F. and Schoutens, W., 2017. Is the capital structure logic of corporate finance applicable to insurers? Review and analysis. Journal of Economic Surveys, 31(1), pp.169-189.
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