Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities

William M. Gentry and David M. Schizer

National Tax Journal, 2003, vol. 56, issue 1, 167-95

Abstract: As financial engineering becomes more sophisticated, taxing income from capital becomes increasingly difficult. We offer the first empirical study of a high profile strategy known as "tax-free hedging," which offers economic benefits of a sale without triggering tax. We explore nontax costs that taxpayers face when hedging by issuing so-called "DECS," "PHONES," and other publicly-traded exchangeable securities. Focusing on 61 transactions between 1993 and 2001, we shed light on why taxpayers might prefer to hedge through private "over-the-counter" transactions: An offering of exchangeable securities is announced in advance and implemented all at once, triggering an almost 4 percent decline in the underlying stock price before the hedge is implemented.

Date: 2003
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Persistent link: https://EconPapers.repec.org/RePEc:ntj:journl:v:56:y:2003:i:1:p:167-95

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