Working Paper: NBER ID: w9243
Authors: William M. Gentry; David M. Schizer
Abstract: As financial engineering becomes more sophisticated, taxing income from capital becomes increasingly difficult. A crucial issue for tax policymakers, then, is the ease or difficulty of implementing tax-advantaged transactions 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 one method of hedging, in which the taxpayer issues publicly-traded exchangeable securities, known by acronyms such as DECS and PHONES. We focus on such offerings between 1992 and 2001, identifying 61 transactions that account for $24 billion in proceeds. Using these publicly-available data, we offer empirical evidence about various frictions that might discourage taxpayers from hedging with exchangeable securities. In so doing, we shed light on why taxpayers might prefer to hedge through private over-the-counter' transactions with derivatives dealers. The main reason is that an offering of exchangeable securities is announced in advance and implemented all at once, triggering an almost four percent decline in the underlying stock price before the hedge is implemented.
Keywords: No keywords provided
JEL Codes: G30; G14; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| announcement of exchangeable securities offering (G12) | decline in underlying stock prices (G10) |
| issuance of hedging security (G10) | decline in underlying stock prices (G10) |
| announcement of exchangeable securities offering (G12) | decline in stock value prior to hedge implementation (G14) |
| issuance of hedging security (G10) | decline in stock valuation (G32) |