External capital market frictions, corporate governance, and the change of effective tax rate: the effect of the TED spread

Abstract

TED spread. TED spread is the difference between the interest rates on interbank loans and short-term U.S. government Treasury Bills (T-bills). As the TED spread increases, the cost of accessing external capital increases because the investors' confidence falls. OLS estimates indicate that while the TED spread peaks, there is a negative effect on the cash-effective tax rate. This negative relation is stronger in more sensitive industries to the TED spread. Furthermore, only firms with good monitoring of managers' actions show a decreased paid corporate tax rate after taking equity compensations as a moderator variable. Thus, when capital from the market is costly, shareholders have the incentive to implement tax savings strategies to generate internal funds. Our final analyses suggest that the tax-saving during high external market frictions positively affects firm value. Our results are robust to various tax avoidance measures and additional macroeconomic control variables.

This study analyzes the effect of external capital market frictions and equity incentives for managers, and their effect on the corporate cash effective tax rate paid by firms in the United States. This study is the first to use a still unexplored external capital market frictions proxy in the study of corporate governance and taxation