In this study, we test for associations between measures of book-tax differences (BTDs) and measures of private bank loan costs. Our measures of bank loan costs are: (1) interest rate spreads, and (2) security requirements. Initial results suggest a positive association between variability in total BTDs, but not levels, and private debt costs. After decomposing BTDs into their permanent and temporary components, we find that temporary BTDs (levels and variability) are consistently positively associated with costs of private debt, whereas permanent BTDs are not. Further, we find that the positive relation between BTDs and costs of private debt is attenuated for high-tax-planning firms and is stronger for loan facilities in which leading lenders have high market shares. Consistent with the findings of Ayers, Laplante, and McGuire (2010), we interpret these results as indicative of BTDs generally impacting the precision of the information conveyed in the financial statements, raising concerns about earnings quality, except where the BTDs likely result from tax planning.
Differences between reported financial statement income and taxable income, or book-tax differences (BTDs), are known to originate from any of several sources, broadly speaking. Simple differences in the accounting rules between Generally Accepted Accounting Principles (GAAP) and the Internal Revenue Code (IRC) are responsible for many book-tax difference items, but BTDs also often arise from decisions made by management (e.g., application of accounting rules, generation of estimates, incorporation of anticipated future events into current accounting, aggressive reporting, etc.). The reflection of managerial judgment in BTDs can make interpretation of them more complex and add to uncertainty surrounding the information conveyed in the financial statements, thus affecting the financial statements' informativeness (Comprix, Graham, & Moore, 2011; Hanlon, 2005). In this study, we examine whether any such information effects of BTDs manifest in bank loan contracting and influence price and non-price costs of private debt. Understanding whether and how the information effects of BTDs impact the costs of private debt is important in part because of the economic significance of private debt. Specifically, bank loans are a major source of external financing for public and private firms worldwide (Bharath, Sunder, & Sunder, 2008; Faulkender & Petersen, 2006; Graham, Li, & Qiu, 2008; Kim, Li, & Li, 2010; Qian & Strahan, 2007; Sufi, 2007), with the global volume of syndicated loans exceeding $2.9 trillion for the first three quarters of 2016 (Thomson Reuters, 2016). Accordingly, deepening our insights on the relation between tax-related reporting and private loan costs will help us to better understand the properties of this pervasive economic transaction. Further, notwithstanding recent research documenting information effects of BTDs on public debt costs (Ayers et al., 2010; Crabtree & Maher, 2009) and effects of tax avoidance on private loan costs (Hasan, Hoi, Wu, & Zhang, 2014; Kim et al., 2010), the literature does not yet provide a clear picture of how the information in tax-related disclosures factors into the costs of borrowing. Specifically, Ayers et al. (2010) find that large positive or negative changes in BTDs are associated with negative changes in credit ratings and attribute this result to large BTDs of either sign having a negative effect on the quality and precision of the information reported in the financial statements (e.g., Hanlon, 2005).