The Relationship of Corporate Tax Avoidance, Cost of Debt and Institutional Ownership: Evidence From Malaysia

The primary aims of this study are to identify whether there is any relationship between corporate tax avoidance and the cost of debt, and whether the level of institutional ownership moderates this relationship, with two hypotheses tests on sample of 110 listed firms in the main board of Bursa Malaysia during the year 2005 – 2009. Two models are constructed for testing two hypotheses of the study. The research framework comprises seven variables. Dependent variable is the cost of debt, while corporate tax avoidance and institutional ownership are independent variables, and four control variables, such as firm age, leverage, firm size, and cash flow from operation. All variables are directly achievable from the data stream and annual reports of firms, excluding tax avoidance. So, in this study book – tax difference (BTD) is used as a proxy for corporate tax avoidance which is developed by Manzon and Plesko (2002) and followed by Desai and Dharmapala (2006, 2009). This study supports prior papers with negative relationship between tax avoidance and the cost of debt, suggesting corporate tax avoidance activity can reduce the cost of debt of the firms. The significant and positive relation statistical result between corporate tax avoidance and the cost of debt indicates that tax – favored effect of corporate tax avoidance can serve as a debt for firms; hence tax avoidance serves as a substitute for the use of debt, which is consistent with trade – off theory. Additionally, the empirical evidence suggests that there is no significant effect of institutional ownership on this relationship, meaning that the level of institutional ownership does not impact on the relationship between tax avoidance and the cost of debt, regardless the level institutional ownership is high or low. This study concludes that first, corporate tax avoidance can reduce the cost of debt, thereby the use of tax – savings instead of debt to finance firm projects; and second, the level of institutional ownership does not have the effect on this relationship, inferring that institutional investors of the sample Malaysian firms might not provide enough scrutiny to which managerial actions on firms` performance are subjected.