Analysis of the effect of Financial Distress on Tax avoidance during the COVID-19 Financial Crisis: Evidence from Pakistan

Abstract

For the purposes to finance their business operations, firms have incentives to engage in corporate tax avoidance activities when managerial incentives increase as compared to managerial costs. These activities are significantly high when firms are inthe financial distress zone. The Covid-19 financial crisis (CFC) provides significant findings on whether corporate tax avoidance hasa significant difference from the pre-Covid-19 tothe post-Covid-19 financial crisis, whether a firm’s management is obligated to engage aggressively with corporate tax avoidance. This research aims to investigate the impact of financial distress on corporate tax avoidance during the Covid-19 financial crisis.  Based on a sample of 175 firms listed on PSX covering the period of 2010-2021. The study applies GMM dynamic approach with (static) fixed and random effect models to check the robustness of results. The finding of the GMM approach demonstrates that financial distress has a statistically significant and positive impact on corporate tax avoidance. Consistent with the cost-benefits analysis and risk-shifting behavior theories, firms engage more in tax avoidance, especially during financial distress. Moreover, CFC magnified the relationship between these variables, and firms investigated in the study face development suffer mostly in this globally and economically distressing period.