DOES INSIDE DEBT MODERATE CORPORATE TAX AVOIDANCE?

Theory suggests that inside debt held by executives in the form of deferred compensation and unfunded pensions serves to align management incentives with creditors, thereby incentivizing them to act more conservatively. Evidence in the literature suggests that creditors favor less aggressive tax avoidance strategies. Accordingly, we investigate whether the level of inside debt is associated with less corporate tax avoidance. Consistent with theoretical predictions and the high level of financial sophistication of the chief financial officer (CFO), we find that the level of inside debt for the CFO, but not chief executive officer (CEO), is associated with less tax avoidance. In addition, we find that the proximity to financial distress magnifies the inverse relation between CFO inside debt and tax avoidance. Our results are robust to numerous supplemental tests, including instrumental variables estimation and matching.