The economic effects of financial derivatives on corporate tax avoidance

•First estimates of the corporate tax savings of financial derivatives.•Large-sample evidence that derivatives users avoid more tax than non-users, and tax savings from tax-timing opportunities.•Difference-in-differences analysis indicates new derivatives users realize economically significant tax savings.•Moves literature beyond notion that companies can use derivatives to avoid tax.•Provides economic insight into prevalence of derivatives-based tax avoidance.

This study estimates the corporate tax savings from financial derivatives. I document a 3.6 and 4.4 percentage point reduction in three-year current and cash effective tax rates (ETRs), respectively, after a firm initiates a derivatives program. The decline in cash ETR equates to $10.69 million in tax savings for the average firm and $4.0 billion for the entire sample of 375 new derivatives users. Of these amounts, $8.75 million and $3.3 billion, respectively, are incremental to tax savings that theory suggests are a byproduct of risk management. Collectively, these findings provide economic insight into the prevalence of derivatives-based tax avoidance.