Capital Gains Taxes, Irreversible Investment, and Capital Structure

Norman Schürhoff
Additional contact information
Norman Schürhoff: HEC, University of Lausanne, FAME.
Authors registered in the RePEc Author Service: Norman Schuerhoff

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: This paper studies the corporate policy distortions caused by realization-based capital gains taxation at the personal level in a dynamic trade-off theory model. The Lock-in effect of embedded capital gains creates severe conflicts of interest between incumbent and new investors. The firm's optimal policy exhibits path-dependency and non-stationarity, since the taxe basis of the firm's owners is a valuable conditioning variable for corporate decisions. Ex-ante identical firms follow very different investment and financial policies depending on their stock price evolution. Firms delay irreversible investment further the lower tax basis of their owners falls. The reason is the investment hedge provided by personal tax loss offsets weakens as investors reset their basis. Capital gains taxation also creates incentives to time equitzy issues. Firms employ more equity in their capital structure the higher the stock price-to-basis ratio, since locked-in investors with out-of-the-money tax timing options value the firm less than the market. The value gain from conditioning on the owner's tax basis is substantial. Using simulated data I show the combined effects are consistent with recent empirical evidence on the relation between leverage, Tobin's Q, and past performance.

Keywords: Capital Gains Taxation; Real Options; Capital Structure; Trade-off Theory; Market Timing. (search for similar items in EconPapers)
JEL-codes: G3 G32 H24 H32 (search for similar items in EconPapers)
Date: 2005-02
New Economics Papers: this item is included in nep-cfn, nep-pbe and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.swissfinanceinstitute.ch/rp131.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.swissfinanceinstitute.ch/rp131.pdf [301 Moved Permanently]--> https://www.sfi.ch/rp131.pdf [302 Found]--> https://www.sfi.ch/en/rp131.pdf)

Related works:
Working Paper: Capital gains taxes, irreversible investment, and capital structure (2004)
Working Paper: Capital Gains Taxes, Irreversible Investment, and Capital Structure (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fam:rpseri:rp131

Access Statistics for this paper

More papers in FAME Research Paper Series from International Center for Financial Asset Management and Engineering Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().