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The Effect of Repeal of the Capital Gain Preference on Venture-Backed Companies

Author

Listed:
  • James R. Hamill

    (University of New Mexico)

  • Inder Khurana

    (University of Missouri)

Abstract

The 1986 Tax Reform Act eliminated preferential tax treatment of capital gains. Proposals to reinstate the preference suggest that risky new investment will suffer without favorable treatment of investment returns. Others have argued that capital for risky new ventures is largely supplied by tax-exempt institutions, who are expected to be indifferent to the taxation of realized gains. This study evaluates the effects of the repeal of preferential capital gains taxation on venture backed firms. The results show negative abnormal returns for sample firms following the Senate’s vote to repeal the capital gain preference. The returns were more negative for firms with a high debt-to-assets ratio, suggesting a more adverse effect for firms relying on equity finance for future capital needs. Sample firms were expected to be particularly sensitive to the tax change, and the results may not be generalizable to other forms of risky investment.

Suggested Citation

  • James R. Hamill & Inder Khurana, 1994. "The Effect of Repeal of the Capital Gain Preference on Venture-Backed Companies," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 3(2), pages 97-109, Spring.
  • Handle: RePEc:pep:journl:v:3:y:1994:i:2:p:97-109
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    References listed on IDEAS

    as
    1. J. E. Stiglitz, 1969. "The Effects of Income, Wealth, and Capital Gains Taxation on Risk-Taking," The Quarterly Journal of Economics, Oxford University Press, vol. 83(2), pages 263-283.
    2. Litzenberger, Robert H. & Ramaswamy, Krishna, 1979. "The effect of personal taxes and dividends on capital asset prices : Theory and empirical evidence," Journal of Financial Economics, Elsevier, vol. 7(2), pages 163-195, June.
    3. Poterba, James M., 1989. "Capital Gains Tax Policy Toward Entrepreneurship," National Tax Journal, National Tax Association;National Tax Journal, vol. 42(3), pages 375-389, September.
    4. Poterba, James M., 1989. "Capital Gains Tax Policy Toward Entrepreneurship," National Tax Journal, National Tax Association, vol. 42(3), pages 375-89, September.
    5. Amoako-Adu, Ben & Rashid, M. & Stebbins, M., 1992. "Capital gains tax and equity values: Empirical test of stock price reaction to the introduction and reduction of capital gains tax exemption," Journal of Banking & Finance, Elsevier, vol. 16(2), pages 275-287, April.
    6. Scholes, Myron S & Wilson, G Peter & Wolfson, Mark A, 1990. "Tax Planning, Regulatory Capital Planning, and Financial Reporting Strategy for Commercial Banks," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 625-650.
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    More about this item

    Keywords

    Capital Gain Preference; Venture Capital; Venture-backed;

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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