Do Taxes Matter: Evidence of Individual and Corporate Tax Incentives on the Choice to Hold Shares Acquired from Exercise of Employee Stock Options

What Does an Executive Stock Sale Tell the Market? Evidence From Sale Transactions Following Stock Option Exercises

“…This finding suggests that liquidity and diversification incentives are less significant factors in the decision to hold or sell at exercise than previously argued. Our findings also extend Huston and Smith (2012) by providing evidence that, while not all sales following the 1-year holding period appear to be based on tax incentives, those sales occurring soon after the 1-year holding period is achieved appear to be at least partially based on tax incentives. Finally, our loss aversion findings provide a novel contribution to the option literature.…”

“…Consequently, while tax benefits could represent an ancillary benefit of holding the shares from exercise, it is an open question as to whether tax incentives cause executives to exit their position once the tax-advantaged holding period has been achieved. Our results provide mixed evidence with respect to Huston and Smith's (2012) conclusion regarding the impact of taxes on the decision to hold shares from exercise. First, we find that more than 75% of all executives who hold their shares for at least 1 year choose not to sell immediately upon attaining tax-advantaged status, suggesting that taxes are not the only motivation for holding shares beyond the 1-year point.…”

“…We next examine whether individual tax incentives impact sales following option exercise. Huston and Smith (2012) find that in approximately 20% of all exercises, insiders hold shares for at least 1 year, inferring that the decision to hold is at least partially driven by the desire to reduce the tax burden on eventual sales, consistent with the Scholes et al (2015) framework. However, they do not document whether executives actually sell upon reaching the 1-year point.…”

“…Aboody et al (2008) challenged the immediate sale assumption, finding that over a quarter of executives hold all shares obtained through exercise for more than 30 days and that these hold-all observations experience positive future returns following exercise, consistent with private information influencing the decision to initially hold. 4 In addition to private information, liquidity and diversification (Aboody et al, 2008;Hemmer et al, 1996;Klein & Maug, 2011;Lambert et al, 1991) and taxes (Cicero, 2009;Huston & Smith, 2012) have also been suggested to impact the timing of sales of shares acquired through option exercise.…”

“…Following the 1991 Securities and Exchange Commission (SEC) revision of ''short swing'' holding rules, stock option literature (Bartov & Mohanram, 2004;Carpenter & Remmers, 2001;Core & Guay, 2001) generally concluded that stock option sales were not based on private information, but this conclusion was driven by the assumption that the exercise and sale occurred simultaneously. However, Aboody et al (2008) and follow-up studies (Brooks et al, 2012;Huston & Smith, 2012;Kyriacou & Mase, 2010) document that between 25% and 33% of shares from option exercises are held rather than sold immediately. Aboody et al (2008) document negative (positive) future returns when executives exercise and immediately sell (initially hold share acquired through exercise), suggesting that insiders' decision to sell or hold at exercise is based on private information.…”