Capital Gains Taxes and IPO Under-Pricing

Abstract:     
We identify initial public offerings (IPOs) as a setting to study the effect of capital gains taxes on asset prices. The initial (first-day) stock returns are a reasonable estimate of the short term taxable gains incurred by initial investors who bought shares at the offer price. If initial investors are able to shift the short-term capital gains tax burden from selling their shares to equity issuers or subsequent buyers, then the magnitude of IPO under-pricing should increase in short-term capital gains taxes. On the other hand, a historically lower long-term capital gains tax rate offers initial investors the benefit of deferring and reducing capital gains taxes by delaying the sale of their shares. If these tax savings are important, then the magnitude of IPO under-pricing should decrease in long-term capital gains tax rate. We provide empirical evidence supporting both predictions. Broadly speaking, our results suggest that taxes play an important role in valuing securities.

Number of Pages in PDF File: 40

JEL Classification: G12, G24, H24, H25

working papers series