Offshore Leaks, Taxes and Capital Structure

Abstract

Recent leaks expose corporate offshore vehicles, commonly used for tax evasion purposes but secret to outsiders, to the public. We examine the capital structure consequence of such exogenous leaks. Using a difference-in-differences approach, we document that firms exposed in offshore leaks significantly increase their financial leverage during the post-leak period, suggesting a substitution effect between offshore tax sheltering and financial leverage. This effect is stronger for firms exposed in offshore leaks via multiple channels, for firms engaged in offshore leaks as entities, and is weaker for firms facing intense competition where the cost of increasing financial leverage and reducing financial flexibility is high. Firms’ overall effective tax rate does not significantly increase after the leaks, further supporting a substitution between offshore tax sheltering and financial leverage.