Capital Gains Taxes, Pricing Spreads and Arbitrage: Evidence from Cross-Listed Firms in the U.S.
Jennifer L. Blouin
University of Pennsylvania - Accounting Department
University of Pennsylvania - The Wharton School
University of California, Davis - Graduate School of Management
January 8, 2009
AFA 2006 Boston Meetings Paper
EFA 2005 Moscow Meetings Paper
We examine how shareholder-level taxes affect the contemporaneous pricing of foreign firms' U.S. cross-listed and underlying home-country securities surrounding the 1997 reduction in U.S. capital gains tax rates. Consistent with tax capitalization, we find that the performance of cross-listed shares is negatively related to dividend yield, suggesting an abnormal price increase for shares with greater anticipated taxable capital gains. Due to barriers to cross-border arbitrage, underlying home-country securities, on average, do not react during the event, creating a temporary tax-induced pricing spread. When costs of arbitrage are low, the pricing disparity quickly dissipates and home-country shares closely mirror the pricing of their cross-listed counterparts. In further tests, we are unable to document lock-in behavior, which predicates a decrease in prices attributable to a surge in volume for shares with greater accrued taxable capital gains. Overall, our findings suggest that an exogenous shock to the U.S. tax regime reverberates in international asset prices, thereby affecting foreign firms' costs of capital.
Number of Pages in PDF File: 57
Keywords: Tax capitalization, Personal taxes, American Depositary Receipts, Arbitrage, Cost of Capital, International Asset Pricing
JEL Classification: H24, G12, G35, G14, G15
Date posted: March 11, 2005 ; Last revised: November 15, 2011