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

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  • Gentry, William M.
  • Schizer, David M.

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.

Suggested Citation

  • Gentry, William M. & Schizer, David M., 2003. "Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities," National Tax Journal, National Tax Association;National Tax Journal, vol. 56(1), pages 167-195, March.
    • Handle: RePEc:ntj:journl:v:56:y:2003:i:1:p:167-95
    DOI: 10.17310/ntj.2003.1S.03
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    References listed on IDEAS

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    1. Lang, Larry & Poulsen, Annette & Stulz, Rene, 1995. "Asset sales, firm performance, and the agency costs of managerial discretion," Journal of Financial Economics, Elsevier, vol. 37(1), pages 3-37, January.
    2. Brent, Averil & Morse, Dale & Stice, E. Kay, 1990. "Short Interest: Explanations and Tests," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(2), pages 273-289, June.
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    Cited by:

    1. Mihir A. Desai & William M. Gentry, 2004. "The Character and Determinants of Corporate Capital Gains," NBER Chapters, in: Tax Policy and the Economy, Volume 18, pages 1-36, National Bureau of Economic Research, Inc.

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