Bank Monitoring and Corporate Tax Planning: Evidence from Loan Covenants

This study examines the effect of bank monitoring on corporate tax planning behavior. To identify the causal effect, we use a regression discontinuity design, taking advantage of the discrete nature of bank control rights surrounding covenant violation thresholds. We find that strengthened bank monitoring triggered by loan covenant violations leads firms to generate more cash tax savings. The positive effect of bank monitoring on cash tax savings is more pronounced among firms without a relationship bank, with severe information asymmetry, facing higher economic policy uncertainty, and having larger institutional ownership before covenant violations. Moreover, we show that there is a decline in tax risk following loan covenant violations. Our findings highlight the important monitoring role of banks in shaping corporate tax planning behavior.