Book-tax trade-off theory and corporate acquisitions: Evidence from China

Abstract

A number of studies in both accounting and finance have examined factors that can inform the choice of a corporate acquisition payment method including tax consideration, but their evidences focus on how a particular payment method can help the acquirers and targets minimize or defer their tax obligations after acquisition. This study tests the applicability of the book-tax trade-off theory in an M&A (merger and acquisition) context. Specifically, we investigate the relationship between an acquirer’s tax avoidance behavior and the choice of an acquisition payment method. We find that a lower (higher) level of tax avoidance is related to the choice of stock (cash) financed acquisitions. Information transparency and corporate governance however can moderate the relationship. Propensity score matching, reverse causality test and other sensitivity analyses support the robustness of the main results. So far as can be determined, this study represents the first effort to validate the book-tax trade-off theory in an M&A context. Being able to identify and explain the relationship between tax avoidance behaviors and the choice of an acquisition payment method based on an established theory allow investors and other M&A stakeholders better assess firm performance and reporting, as well as potential tax obligations after acquisitions.