Mutual Funds’ Capital Gains Lock-in and Earnings Management
61 Pages Posted: 30 Dec 2019 Last revised: 3 May 2023
Date Written: April 28, 2023
Abstract
Capital gains taxation creates a lock-in effect, increasing investors’ incentives to monitor and decreasing portfolio firms’ incentives to cater to short-term investors. We show a negative relation between lock-in and portfolio firms’ earnings management, and this relation is stronger for capital gains held by tax-sensitive investors. Further, the relation between lock-in and earnings management is stronger when the capital gains tax rate is higher. We show that locked-in funds vote against management and against audit committee members’ reappointment following earnings management. Locked-in funds are less likely to exit a position following disappointing earnings announcements, reducing firms’ incentive to manage earnings.
Keywords: Earnings Quality, Earnings Management, Capital Gains Tax, Capital Gains Lock-in, Mutual Funds
JEL Classification: M40, M41, G23, G34, H20
Suggested Citation: Suggested Citation