Capital Gains Tax Overhang and Price Pressure

Abstract

I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax-sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax-exempt clients. Moreover, tax-related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax-sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly. Copyright 2006 by The American Finance Association.

Long-term return reversals—Value and growth or tax? UK evidence

“…This evidence is consistent with the capital gain lock-in effect Jin (2006). investigates whether the capital gain tax is an impediment to selling and he finds that selling decisions are negatively influenced by an amount of cumulative capital gains for institutional investors, who have a large number of tax-sensitive clients.…”

Effect of personal taxes on managers’ decisions to sell their stock

“…Table 9 reports results of comparing the selling behavior of CEOs with those of taxable institutions. Institutions with mainly taxable clientele are identified using the approach developed in Jin (2006). In particular, using the investor profiling information obtained from the Investment Adviser Public Disclosure (IAPD) data maintained by the SEC, we classify as taxsensitive those institutions whose clientele consists primarily (X50%) of tax-sensitive investors such as high net worth individuals.…”

Firm valuation, abnormal earnings, and mutual funds flow

“…Second, in order to examine the differential impact based on the firm's unexpected earnings, we use quarterly data as Found evidence of stock price increases for firms added to the S&P 500, but did not see corresponding price decreases for firms remove from the index. They interpreted this phenomenon as consistent with Merton's (1987) investor awareness argument: once a stock is known, it does not become unknown Jin (2006) ''Capital Gains Tax Overhang and Price Pressure''…”

“…A major subset of these studies have looked at events or circumstances peculiar to a company such as being added to or removed from an S&P index. These studies find evidence, at least on the surface, of a price pressure effect (Harris and Gurel 1986;Schleifer 1986;Jain 1987;Lynch and Mendenhall 1997;Cha and Lee 2001;Chen et al 2004;Jin 2006). Several of these studies (Jain 1987;Lynch and Mendenhall 1997;Cha and Lee 2001;Chen et al 2004) while observing the price pressure, argue that it is related to an information event, e.g.…”