Capital Gains Taxes, Pricing Spreads and Arbitrage: Evidence from Cross-Listed Firms in the U.S

Jennifer L. Blouin, Luzi Hail, Michelle Yetman
2009 Social Science Research Network  
This paper examines how shareholder-level taxes affect the pricing of foreign firms' cross-listed stocks in the U.S. and what role cross-country arbitrage plays in mitigating this effect. Specifically, we study how an unexpected reduction in U.S. capital gains taxes at the announcement of the 1997 budget accord changes the pricing of cross-listed shares relative to their underlying home country stocks. If the marginal investor in the cross-listed share is a U.S. taxable individual, we expect to
more » ... find a significant stock price reaction to the external shock. Absent arbitrage, home country stock prices should be largely unaffected by the change in U.S. tax rates. Consistent with tax capitalization, we find that the performance of cross-listed shares in the U.S. is negatively and significantly related to dividend yield during the announcement week. Home country shares generally do not react to the announcement, creating a tax-induced pricing spread. Evidence suggests that cross-country arbitrage partially mitigates this disparity as the spread becomes smaller -and eventually disappears -when we limit the sample to the more and more liquid firms. Overall, our findings indicate that changes in U.S. tax legislation have the potential to affect asset prices in foreign markets.
doi:10.2139/ssrn.677040 fatcat:nfieyryio5gqfh7xqvetwb3g4e