Tax Avoidance Of M&A And Its Economic Consequences

Mergers and acquisitions take place primarily because of’ownership advantages’. Ownership advantages arise when a change in ownership of the target firm is expected to provide a source of value creation, either by increasing the target’s expected future cash flows or decreasing risk. There are many possible sources of ownership advantages. While there is an extensive literature on the change in operating and management performance following mergers and acquisitions (such as operating synergy and corporate governance improvement), the potential importance of tax management has been ignored.Realizing tax avoidance, which also means lowering the combined firm’s tax burden, is one important way that an acquiring firm can generate ownership advantages. In this study, I investigate the existence of tax avoidance around merger and acquisition and its economics consequence. To be specific, this study tries to address the three questions below:1.what’s the possible sources of tax avoidance around merger and acquisition and whether it do exist? 2. Whether tax avoidance is a driver of merger and acquisition, or just an unintended consequence of that? 3. What’s the effect of tax avoidance around merger and acquisition on merger premium, cumulative abnormal return of acquirer and merger performance.In theory analysis and hypothesis development section, I begin by investigating the possible sources of tax avoidance around M&A, including increased utilization of loss carryforward, stepped up asset basis, more efficient tax management, untapped tax gain through additional debt and lower ETR by through transfer price or debt shifting. I then develop an analytical model aimed at investigating whether the tax avoidance asymmetry between merger and acquisition and greenfield investment affects firm’s choice of investment mode. Finally, I investigate the impact of tax avoidance around M&A on merger premium, cumulative abnormal return of acquirer and merger performance.In line with hypotheses development, I conduct the following three empirical tests.I begin by employing difference in difference model aimed at examining whether tax avoidance around merger and acquisition exists. I find that, compared with greenfield investment, the acquirer’s total book-tax difference increases and the GAAP and cash effect tax rates decrease following M&A, indicating that merger and acquisition do drive tax avoidance. Further, we find that the magnitude of tax avoidance in different transaction structure of M&A is asymmetric.I then test whether the tax avoidance asymmetry between merger and acquisition and greenfield investment affect firm’s choice of investment mode. I find that, from ex-anti perspective, the asymmetric tax avoidance above will significantly affect the firm’s choice of investment mode and statistic data suggests that tax avoidance is one of drivers of merger and acquisition.Finally, I test the economic consequences of tax avoidance. More specifically, I test the impact of tax avoidance around M&A on merger premium, cumulative abnormal return of acquirer around an acquisition announcement date and merger performance. I find that:1. There is no evidence that merger premium is associated with tax avoidance around M&A, indicating that nowadays the bidder hasn’t realized the benefit of tax avoidance to acquirer and therefor hasn’t asked a higher price for that.2. Acquirer’s cumulative abnormal return around an acquisition announcement date is positively associated with tax avoidance around M&A, suggesting that tax benefit in M&A provides a source of value creation and are acknowledged by capital market.3. Tax avoidance is helpful to explain the merger performance mystery-accrual based merger performance decreases following M&A, while cash flow based merger performance increases.4. Variation in merger premium is not associated with merger performance, indicating that there is no evidence supporting the hypothesis that higher merger premium drives bad merger performance.Compared to prior studies, this study makes several contributions. First, I provide a more complete picture of how merger and acquisition realizes tax avoidance benefits and first introduce difference in difference method into this area research to prove our hypotheses with avoiding the empirical endogeneity problem. Second, to our knowledge, mine is the first study that develops an analytical and an empirical model to investigates the effect of tax avoidance on the choice of investment mode, which extends and expand related research that only focus on the effect of tax rate on investment mode. Finally, this study expands the research range of economic consequences of tax avoidance around M&A and provides an explanation for merger performance mystery from tax perspective.