Capital Gains Taxes and Expected Rates of Return
Sikes, Stephanie A., Verrecchia, Robert E.
The Accounting Review · 2012 · Volume 87 · Issue 3
Abstract
Prior literature predicts a positive relation between firms' expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm's systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because, in addition to reducing investors' expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.
Keywords
taxes, asset pricing, expected return
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