The impact of tax policy on firm debt maturity: Evidence from China's VAT reform

This paper mainly discusses how tax reduction policies may affect a firm's debt maturity structure by altering firm performance. When an indirect financing system is dominated by banks, such as is the situation in China, tax reduction policies impose two opposite effects on the firm debt maturity structure. The improved profitability will encourage banks to lengthen debt maturity to retain firm customers, which can be called the 'customer competing effect'. Meanwhile, the increased free cash flow will exaggerate the principle-agent problem between banks and firms, leading to a shortened debt maturity, which is designated the 'agency cost effect'. In this paper, based on China's Industrial Enterprise Database, we use China's VAT (value-added tax) reform as a natural experiment to empirically test the two effects. After the tax reduction, firm debt maturity was found to generally lengthen. Meanwhile, such an extension is found to be larger when the firm's profit gain is greater or the increased free cash flow is less, which confirms our hypothesis.