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
Date Written: September 29, 2011
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: Suggested Citation