External capital market frictions, corporate governance, and tax avoidance: Evidence from the TED spread

This study investigates whether corporate tax avoidance can benefit shareholders when external capital market frictions are high. Using the TED spread as an exogenous shock to firm financial constraint, the study documents that firms tend to reduce their effective tax rates more aggres-sively when external financing is very costly. This negative relation is stronger in industries more sensitive to TED. Furthermore, we find that the positive effect of TED on tax avoidance is more pronounced within firms with good corporate governance. Our final analyses suggest that the tax-savings during the time of high external market frictions positively affect firm value and the positive effect on firm value is stronger within firms with good corporate governance.