Effect of Tax Avoidance on Cost of Capital in Nigeria

Abstract

The study explored the relationship between tax avoidance and the cost of capital among publicly listed firms in Nigeria from 2010 to 2022. Using a simple random sampling technique, the sample included 30 firms across five sectors. Secondary data were sourced from annual reports of the selected firms and fact books from the Nigerian Stock Exchange (NSE). The cost of capital, comprising cost of equity and cost of debt, was analyzed with tax avoidance measured by the firm's cash effective tax rate. Control variables included leverage, return on assets, return on equity, firm size, and board size. A panel fixed effects panel regression analysis, selected after a Hausman pre-test, was employed alongside "Driscoll-Kraay standard errors" to address heteroscedasticity and autocorrelation issues. Results from the panel fixed effects analysis indicated that tax avoidance significantly and positively affects both the cost of equity and the cost of debt, highlighting tax avoidance as a key factor in firms' financing decisions and investors' choices. Further analysis using system GMM two-step estimators confirmed the panel fixed effect results, underscoring their robustness and revealing a bidirectional relationship between tax avoidance and cost of debt, suggesting reverse causality. To address these implications, policymakers are urged to implement regulatory measures encouraging voluntary tax compliance and clear tax law interpretations to curb aggressive tax avoidance, thereby reducing firms' cost of capital. Additionally, firms should enhance transparency by disclosing operational details to shareholders, fostering investor confidence and influencing their perceptions of risk and the associated cost of capital.