Norman Schürhoff (HEC, University of Lausanne, FAME.)
Abstract
This paper studies the corporate policy distortions caused by realization-based capital gains taxation at the personal level in a dynamic trade-off theory model. The Lock-in effect of embedded capital gains creates severe conflicts of interest between incumbent and new investors. The firm's optimal policy exhibits path-dependency and non-stationarity, since the taxe basis of the firm's owners is a valuable conditioning variable for corporate decisions. Ex-ante identical firms follow very different investment and financial policies depending on their stock price evolution. Firms delay irreversible investment further the lower tax basis of their owners falls. The reason is the investment hedge provided by personal tax loss offsets weakens as investors reset their basis. Capital gains taxation also creates incentives to time equitzy issues. Firms employ more equity in their capital structure the higher the stock price-to-basis ratio, since locked-in investors with out-of-the-money tax timing options value the firm less than the market. The value gain from conditioning on the owner's tax basis is substantial. Using simulated data I show the combined effects are consistent with recent empirical evidence on the relation between leverage, Tobin's Q, and past performance.
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Publisher Info
Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number
rp131.
Find related papers by JEL classification: G3 - Financial Economics - - Corporate Finance and Governance G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
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