Capital Gains Taxes and Stock Reactions to Quarterly Earnings Announcements

This paper examines the impact of capital gains taxes on equity pricing. Examining three-day cumulative abnormal returns for quarterly earning announcements from 1983-1997, we present evidence consistent with shareholders' capital gains taxes affecting stock price responses. To our knowledge, this is the first study to link shareholder taxes and share price responses to earnings releases. The results imply that shares trade at higher (lower) prices when individual investors face incremental taxes (tax savings) created by selling appreciated (depreciated) shares before they qualify for long-term treatment. Unlike prior studies that have focused on price reactions in settings where shareholder taxes are unusually salient (e.g., tax law changes, turn-of-the-year trading, or tax-sensitive transactions), this study finds the imprint of capital gains taxes in a more general setting.