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

Posted: 19 Aug 2003

See all articles by William M. Gentry

William M. Gentry

Williams College - Department of Economics

David M. Schizer

Columbia University - Law School

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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 5 percent decline in the underlying stock price before the hedge is implemented.

Keywords: DECS, frictions, constructive sales, hedging, capital gains

JEL Classification: G30, G14, H25

Suggested Citation

Gentry, William M. and Schizer, David M., Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities. Available at SSRN: https://ssrn.com/abstract=426340

William M. Gentry

Williams College - Department of Economics ( email )

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David M. Schizer (Contact Author)

Columbia University - Law School ( email )

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