Capital Gains Taxes and Expected Rates of Return

The Accounting Review, Vol. 87, No. 3, May 2012

Posted: 1 Oct 2011 Last revised: 25 Jan 2014

See all articles by Stephanie A. Sikes

Stephanie A. Sikes

University of Pennsylvania - Accounting Department

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Date Written: September 29, 2011

Abstract

Prior literature predicts a positive relation between firms’ expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm’s systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because in addition to reducing investors’ expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.

Keywords: Taxes, Asset Pricing, Expected Return

JEL Classification: G10, G12, H24

Suggested Citation

Sikes, Stephanie A. and Verrecchia, Robert E., Capital Gains Taxes and Expected Rates of Return (September 29, 2011). The Accounting Review, Vol. 87, No. 3, May 2012. Available at SSRN: https://ssrn.com/abstract=1935672 or http://dx.doi.org/10.2139/ssrn.1935672

Stephanie A. Sikes (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Robert E. Verrecchia

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6976 (Phone)
215-573-2054 (Fax)

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