The Journal of Finance

Tax‐Induced Intertemporal Restrictions on Security Returns

Published: 09/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb02457.x

PETER BOSSAERTS, ROBERT M. DAMMON

This article derives testable restrictions on equilibrium asset prices when investors have the option to time the realization of their capital gains and losses for tax purposes. The tax‐timing option alters both the magnitude and timing of equity returns relative to those in a tax‐free model. The tax‐induced restrictions are empirically examined, and the tax rates and preference parameters are estimated. While the tax‐free model can be rejected in favor of the tax‐based model as the specified alternative, the tax‐based model is still unable to adequately explain cross‐sectional differences in asset returns.

Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets

Published: 12/01/1987   |   DOI: 10.1111/j.1540-6261.1987.tb04358.x

ROBERT M. DAMMON, RICHARD C. GREEN

In models where both investors and securities are subject to differential taxation, there may be no set of prices that rule out infinite gains to trade, or “tax arbitrage.” This paper characterizes the joint restrictions on financial‐asset returns and investors' tax schedules that preclude tax arbitrage in the absence of short‐sale constraints. The authors show that, if there exists any configuration of marginal tax rates on investors' tax schedules that rule out infinite gains to trade, then “no‐tax‐arbitrage” prices will exist. They also show that the existence of “no‐tax‐arbitrage” prices ensures the existence of equilibrium prices.

An Option‐Theoretic Approach to the Valuation of Dividend Reinvestment and Voluntary Purchase Plans

Published: 03/01/1992   |   DOI: 10.1111/j.1540-6261.1992.tb03988.x

ROBERT M. DAMMON, CHESTER S. SPATT

Many firms with dividend reinvestment plans also allow their shareholders to voluntarily invest supplemental funds to purchase additional shares. The purchase price for newly‐issued shares often is determined by the average stock price over a prespecified time period preceding the investment date. This gives the firm's shareholders an option to invest in additional shares only when the stock price exceeds the computed average. This paper uses both theoretical and numerical methods to analyze the value of these voluntary purchase options in theory and practice.

The Effect of Taxes and Depreciation on Corporate Investment and Financial Leverage

Published: 06/01/1988   |   DOI: 10.1111/j.1540-6261.1988.tb03944.x

ROBERT M. DAMMON, LEMMA W. SENBET

This paper provides an analysis of the effect of corporate and personal taxes on the firm's optimal investment and financing decisions under uncertainty. It extends the DeAngelo and Masulis capital structure model by endogenizing the firm's investment decision. The authors' results indicate that, when investment is allowed to adjust optimally, the existing predictions about the relationship between investment‐related and debt‐related tax shields must be modified. In particular, the authors show that increases in investment‐related tax shields due to changes in the corporate tax code are not necessarily associated with reductions in leverage at the individual firm level. In cross‐sectional analysis, firms with higher investment‐related tax shields (normalized by expected earnings) need not have lower debt‐related tax shields (normalized by expected earnings) unless all firms utilize the same production technology. Differences in production technologies across firms may thus explain why the empirical results of recent cross‐sectional studies have not conformed to the predictions of DeAngelo and Masulis.

Optimal Asset Location and Allocation with Taxable and Tax‐Deferred Investing

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00655.x

Robert M. Dammon, Chester S. Spatt, Harold H. Zhang

We investigate optimal intertemporal asset allocation and location decisions for investors making taxable and tax‐deferred investments. We show a strong preference for holding taxable bonds in the tax‐deferred account and equity in the taxable account, reflecting the higher tax burden on taxable bonds relative to equity. For most investors, the optimal asset location policy is robust to the introduction of tax‐exempt bonds and liquidity shocks. Numerical results illustrate optimal portfolio decisions as a function of age and tax‐deferred wealth. Interestingly, the proportion of total wealth allocated to equity is inversely related to the fraction of total wealth in tax‐deferred accounts.