Cross-Country Evidence on the Relation between Capital Gains Taxes, Risk, and Expected Returns

57 Pages Posted: 27 Feb 2014 Last revised: 16 Jan 2016

See all articles by Luzi Hail

Luzi Hail

University of Pennsylvania - The Wharton School; European Corporate Governance Institute (ECGI)

Stephanie A. Sikes

University of Pennsylvania - Accounting Department

Clare Wang

University of Colorado at Boulder - Leeds School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: November 27, 2015

Abstract

This study empirically examines the role of risk sharing between taxable investors and the government on the relation between capital gains taxes and expected returns. Specifically, using an international panel from 26 countries over the period 1990 to 2004, we find evidence that the general positive relation between capital gains taxes and expected returns becomes weaker or even reverses when (i) a firm’s systematic risk is high, (ii) the market risk premium is high, or (iii) the risk-free rate is low. The results are particularly pronounced in countries with substantive changes in tax rates, more trust in government institutions, less integrated and less liquid capital markets, and lower foreign institutional ownership as well as around substantive increases and decreases in the risk parameters. We corroborate our findings in a single country setting, using the 1978, 1997, and 2003 capital gains tax rate changes in the United States as events. Our results underscore the importance of macroeconomic and firm-specific factors in determining the effect of tax capitalization, and suggest that tax rate changes can sometimes have opposite valuation implications than what policymakers have in mind.

Keywords: Tax capitalization, Personal taxes, Market risk, Cost of capital, Risk sharing, International economics

JEL Classification: G12, G15, G32, H24, K34, M41

Suggested Citation

Hail, Luzi and Sikes, Stephanie A. and Wang, Clare, Cross-Country Evidence on the Relation between Capital Gains Taxes, Risk, and Expected Returns (November 27, 2015). Available at SSRN: https://ssrn.com/abstract=2401511 or http://dx.doi.org/10.2139/ssrn.2401511

Luzi Hail

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-8205 (Phone)
215-573-2054 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Stephanie A. Sikes (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Clare Wang

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
443
Abstract Views
5,661
Rank
68,524
PlumX Metrics