Financial distress and tax avoidance: the moderating effect of the COVID-19 pandemic

Abstract

PurposeThis paper examines whether financial distress is associated with tax avoidance and whether the COVID-19 pandemic moderates such association.Design/methodology/approachThe sample covers 38,958 firm-year observations from 32 countries during the period 2015–2020. Financial distress is measured using the ZSCORE by Altman (1968), while tax avoidance is based on the book-tax difference.FindingsFinancially distressed firms exhibit low tax avoidance pre- and during the pandemic periods. The authors find higher tax avoidance during the pandemic compared to the pre-pandemic period, but the pandemic enhances the negative relationship between financial distress and tax avoidance.Research limitations/implicationsThe study offers evidence on how financial distress drives firms to engage in more tax avoidance when firms globally encountered various levels of financial difficulty sparked by the economic challenges of the COVID-19 pandemic.Practical implicationsThe findings provide insights to policymakers on the need to monitor and incentivise financially distressed firms, especially during economic challenges due to pandemic.Originality/valueThis study adds to the limited, albeit important, evidence on the joint effect of the COVID-19 pandemic and financial distress on tax avoidance.