M. Emrul Hasan, CFA, FRM
Simon Fraser University
Publications and Working Papers
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Abstract
This paper uses an even-study setting to test the effect of capital gains tax “lock-in” on abnormal issuance day returns of SEOs. We find that the abnormal negative offering day return is more negative for stocks with higher accrued gains prior to the SEO. This larger drop in offer day closing price from pre-SEO price stems from the weakening of the reluctance to sell by the locked-in investors as more shares are available in the market due to the SEO (Hasan, 2016). This reduces investor’s post-SEO “deferral” or “lock-in” term as developed by Klein (1998). We use 1 year, 2 year and 3 year accrued gains to proxy lock-in. We find that SEO shares with high accrued gains (more locked-in) before issuance experience more decline in prices after issuance. Our empirical examination of U.S. SEOs between 1990 and 2012 strongly supports this contention. We also find that the negative issuance date return is related to offer size and offer price rounding. Our findings are robust to various sub-samples and alternative definitions of lock-in.
JEL codes: G12; G14; G31; G32; H22
Keywords: Seasoned equity issues; SEOs; Capital Gains Tax; “Lock-in”; Equity financing; Event Study; Public Policy
Link: Available upon request. Email mhasan@sfu.ca.
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Abstract:
This paper presents a general equilibrium model that helps explain the price movement of equity before and after SEO in the presence of capital gains taxes. We theoretically document how investor’s deferral or “lock-in” term, as developed by Klein (1998), reacts to an SEO that increases the existing number of shares in the market. We argue with the model and numerical examples that prices and returns around SEO, reflect tax “lock-in” effect, and this “lock-in” term decreases from pre-SEO to post-SEO. This reduction in “lock-in” should decrease the post-SEO price from pre-SEO price, and helps explain the negative SEO offer day return puzzle ceteris paribus.
JEL Codes: D53, G11, G12, H22
Keywords: Capital gains tax, “Lock-in”, General equilibrium model, SEO
Link: Available upon request. Email mhasan@sfu.ca.
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Abstract
We use the initial public offerings (IPOs) of U.S. common stocks as a platform to explain the capital gains tax “lock-in” effect. We contend that the “lock-in” effect around IPOs is induced by the U.S. tax codes that allow a preferential tax treatment for long-term (LT) holdings where long-term capital (LT) gains are taxed at a lower rate than short-term (ST) gains. At first, applying Klein’s (1998) “lock-in” model on IPOs, we show that for initial investors who just subscribed to the IPOs, their “lock-in” is explained by the differential ST and LT tax rates along with accrued first day gains ceteris paribus. We find that post-IPO equilibrium price increases with the magnitude of the difference between the ST and LT tax rates. Then, using a large sample of IPOs from 1987 to 2015, we perform several empirical tests and find consistent results with the model outcome that the first day returns of IPOs increases with ST and LT tax rate differential supporting tax “lock-in”.
JEL Codes: D53, G11, G12, H22
Keywords: Capital gains tax, “Lock-in”, General equilibrium model, IPO, Underpricing
Link: Available upon request. Email mhasan@sfu.ca.
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Key Conclusions:
- Auto insurance premium costs in provinces with government auto insurance monopolies tend to be higher than observed in private sector, competitive markets
- From 2007 to 2009, auto insurance has been most costly and least affordable in British Columbia, Ontario, Manitoba, and Saskatchewan— three of which are provinces with government-run auto insurance monopolies. Auto insurance premiums have been consistently most affordable in Alberta, Newfoundland & Labrador, Nova Scotia, Prince Edward Island, and New Brunswick, where auto insurance is delivered in a regulated, competitive, private-sector insurance market.
- In 2009, Ontario was the province with the least affordable auto insurance. Regulatory severity and insurance fraud have led to higher claim costs per passenger vehicle.
- Of the four provinces that each have a public auto insurer, Quebec has consistently ranked best on insurance costs, and in 2009 had the lowest average auto insurance premium of all the provinces. Two factors contribute to this performance: the limitation of the public monopoly to bodily injury claims coverage and less severe regulations than the other three provinces.
Link: “Personal Cost and Affordability of Auto Insurance in Canada.”
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Key Conclusions:
The findings show that tougher regulations in Canada are actually making auto insurance more unaffordable. Rate regulations create high costs for insurers via moral hazard and adverse selection. If solvency regulations become onerous, they can cause investment returns to go down. At the same time, mandatory minimum coverage regulations raise the product redesign costs and hinder insurer innovation. These will all lead to higher costs for insurers, and consumers will pay for these costs through elevated premiums.
Premium prices can be determined either by competitive pricing, where market forces set the price through effective competition among a large number of players, or by regulatory pricing where regulators set the prices through different levels of rate setting and product design regulations. The latter clearly doesn’t work. Then what policy will benefit consumers? Leadbetter et al. (2004) suggested using competitive pricing in auto insurance settings. Their empirical study found that premium volatility in Ontario began increasing following the introduction of rate regulation in 1989. Prior to this, unexplained volatility in Ontario’s automobile insurance premiums was less than for Alberta and the Atlantic provinces, which operated with rate regulatory regimes while Ontario allowed prices to be determined by market forces. Therefore, scaling back regulatory severity and allowing prices to be determined by market forces will benefit consumers. Empirical evidence and economic principles suggest that as long as prices are determined by competition rather than by rate regulation, solvency is appropriately regulated (see Harrington, 1991) and consumers have the freedom to choose the kind of auto insurance they need, and we should expect to observe lower premiums in Canada.