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Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities

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  • William Gentry
  • David M. Schizer

Abstract

As financial engineering becomes more sophisticated, taxing income from capital becomes increasingly difficult. A crucial issue for tax policymakers, then, is the ease or difficulty of implementing tax-advantaged transactions We offer the first empirical study of a high profile strategy known as tax-free hedging,' which offers economic benefits of a sale without triggering tax. We explore one method of hedging, in which the taxpayer issues publicly-traded exchangeable securities, known by acronyms such as DECS and PHONES. We focus on such offerings between 1992 and 2001, identifying 61 transactions that account for $24 billion in proceeds. Using these publicly-available data, we offer empirical evidence about various frictions that might discourage taxpayers from hedging with exchangeable securities. In so doing, we shed light on why taxpayers might prefer to hedge through private over-the-counter' transactions with derivatives dealers. The main reason is that an offering of exchangeable securities is announced in advance and implemented all at once, triggering an almost four percent decline in the underlying stock price before the hedge is implemented.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9243.

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Date of creation: Sep 2002
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Publication status: published as Gentry, William M. and David M. Schizer. "Frictions And Tax-Motivated Hedging: An Empirical Exploration Of Publicly-Traded Exchangeable Securities," National Tax Journal, 2003, v56(1,Supp), 167-195.
Handle: RePEc:nbr:nberwo:9243

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Cited by:
  1. Mihir Desai & William M. Gentry, 2003. "The Character and Determinants of Corporate Capital Gains," NBER Working Papers 10153, National Bureau of Economic Research, Inc.
  2. Anna Danielova & Scott Smart, 2012. "Stock Price Effects of Mandatory Exchangeable Debt," International Advances in Economic Research, Springer, vol. 18(1), pages 40-52, February.

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