Abstract

http://ssrn.com/abstract=2401511
 


 



Cross-Country Evidence on the Relation between Capital Gains Taxes, Risk, and Expected Returns


Luzi Hail


University of Pennsylvania - The Wharton School

Stephanie A. Sikes


University of Pennsylvania - The Wharton School

Clare Wang


Northwestern University - Kellogg School of Management

August 1, 2014


Abstract:     
This study empirically examines the prediction in Sikes and Verrecchia (2012) that the relation between capital gains tax rates and expected rates of return varies in the cross-section and over time with firm risk and market risk. Specifically, we test whether the general positive relation between expected returns and the capital gains tax rate becomes weaker or even reverses when (i) a firm’s systematic risk is high, (ii) the market risk premium is high, or (iii) the risk-free rate is low. Using an international panel from 27 countries over the period 1990 to 2004, we find evidence supporting these predictions. The results are particularly pronounced in countries with substantive changes in tax rates, more trust in government institutions, less integrated and less liquid capital markets, and lower institutional ownership as well as around substantive increases and decreases in the three risk proxies. We corroborate our findings in a single country setting, using the 1978, 1997, and 2003 changes to the capital gains tax rate in the United States as events. Our results underscore the importance of macroeconomic and firm-specific factors in determining the effect of capital gains taxes on expected returns and suggest that tax rate changes can sometimes have opposite valuation implications than what policymakers have in mind.

Number of Pages in PDF File: 67

Keywords: Tax capitalization, Personal taxes, Market risk, Cost of capital, International economics

JEL Classification: G12, G15, G32, H24, K34, M41

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Date posted: February 27, 2014 ; Last revised: August 4, 2014

Suggested Citation

Hail, Luzi and Sikes, Stephanie A. and Wang, Clare, Cross-Country Evidence on the Relation between Capital Gains Taxes, Risk, and Expected Returns (August 1, 2014). Available at SSRN: http://ssrn.com/abstract=2401511 or http://dx.doi.org/10.2139/ssrn.2401511

Contact Information

Luzi Hail
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-8205 (Phone)
215-573-2054 (Fax)
Stephanie A. Sikes (Contact Author)
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
Clare Wang
Northwestern University - Kellogg School of Management ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
847 491 2670 (Phone)
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