The Role of Creditor Protection in Lending and Tax Avoidance

Abstract

We examine how creditor rights affect the trade-off between non-debt and debt tax shields. Using four bankruptcy reforms and a panel of private and public firms from Italy, we show that laws empowering creditors reduce tax avoidance and increase debt financing, consistent with firms substituting non-debt tax shields with debt tax shields. We corroborate the validity of our findings using a panel of public firms across 33 countries. Additionally, we document that the impact of creditor protection laws is mitigated by tax system characteristics, which significantly reduce the incentives to substitute tax avoidance with debt.