Tax Risk and Asset Prices: Evidence from Dual-class Corporate Bonds in the Early 19th Century

72 Pages Posted: 3 May 2019 Last revised: 25 May 2019

See all articles by Matthias Fleckenstein

Matthias Fleckenstein

University of Delaware

Priyank Gandhi

Rutgers Business School, Newark and New Brunswick

Pengjie Gao

University of Notre Dame - Mendoza College of Business

Date Written: May 22, 2019

Abstract

This paper exploits a natural experiment from the late 1800s in which many U.S. firms had inadvertently issued both taxable and tax-exempt bonds. Investors paid income tax on taxable bonds, but firms covered income tax on investors' behalf on tax-exempt bonds. Using a unique data-set of these `dual-class' corporate bonds, we derive a novel, market-based measure for tax risk, examine its time-series properties, and investigate if tax risk is priced in asset returns. We find that tax risk is pro-cyclical, is priced in the cross-section of asset returns, and commands a statistically and economically significant positive risk premium.

Keywords: Tax, Tax risk, Asset prices, Cross-section of returns

JEL Classification: G10, G12, G13, G18, H22, H24, N21, N22, H71

Suggested Citation

Fleckenstein, Matthias and Gandhi, Priyank and Gao, Pengjie, Tax Risk and Asset Prices: Evidence from Dual-class Corporate Bonds in the Early 19th Century (May 22, 2019). Available at SSRN: https://ssrn.com/abstract=3364309 or http://dx.doi.org/10.2139/ssrn.3364309

Matthias Fleckenstein

University of Delaware ( email )

419 Purnell Hall
Newark, DE 19716
United States
3028314936 (Phone)

HOME PAGE: http://www.mfleckenstein.com

Priyank Gandhi (Contact Author)

Rutgers Business School, Newark and New Brunswick ( email )

111 Washington Avenue
Newark, NJ 07102
United States

Pengjie Gao

University of Notre Dame - Mendoza College of Business ( email )

246 Mendoza College of Business
Notre Dame, IN 46556-5646
United States
(574) 631-8048 (Phone)

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