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Capital Gains Tax Overhang and Price Pressure


  • LI JIN

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    • Harvard Business School. I thank an anonymous referee for extremely helpful suggestions. I also thank Andrew Alford, Malcolm Baker, Daniel Bergstresser, Long Chen, Joshua Coval, Dwight Crane, Mihir Desai, Benjamin Esty, Paul Gompers, Robin Greenwood, Stephen Kaplan, S.P. Kothari, Blake LeBaron, Joshua Lerner, Jay Light, Robert Merton, Randall Morck, Don Mulvihill, Stewart Myers, Andre Perold, Jeffrey Pontiff, James Poterba, Edward Qian, Hank Reiling, Richard Ruback, David Scharfstein, Anna Scherbina, Douglas Schackelford, Chester Spatt, Erik Stafford, Laura Starks, Jeremy Stein, Peter Tufano, Luis Viceria, Scott Weisbenner, Harold Zhang, Bin Zhou, Luigi Zingales, an associate editor, and the editor, Robert Stambaugh, as well as participants at seminars at several universities and asset management firms and the American Finance Association Annual Meeting for offering valuable suggestions. I acknowledge the excellent research assistance of Jennifer Chu, Bryan Lincoln, Steven Oliveira, Michael Sorell, Deborah Strumsky, and Zhijie Xue, and editorial assistance by Jennifer Chu and John Simon. I thank I/B/E/S for providing analyst forecast data, and SEC for providing data on investment advisor profiles. I am grateful to the extensive effort of the Harvard Business School Special Projects Group, led by Toni Wegner, in cleaning up the data used in this project. I also benefited from talks with David Granger and Melvyn Gonzalez at Thomson Financial that enabled me to better understand the CDA/Spectrum data. Research support from the Harvard Business School Division of Research is gratefully acknowledged. All remaining errors are my own.


I study whether the capital gains tax is an impediment to selling by some investors and if so, to what degree associated delayed selling affects stock prices. I find that selling decisions by institutions serving tax-sensitive clients are sensitive to cumulative capital gains, a pattern not observed for institutions with predominantly tax-exempt clients. Moreover, tax-related underselling impacts stock prices during large earnings surprises for stocks held primarily by tax-sensitive investors. The corresponding price reactions are less negative (more positive) with higher cumulative capital gains. This price pressure pattern is more severe when arbitrage is more costly.