Influence of Capital Gains Tax Policy on Credibility of Unverified Disclosures

Abstract

ABSTRACT: In this study, we consider the effects of the asymmetry in capital gains tax policy on the communication of private information to investors. Assuming quite plausibly that firm managers tend to favor current stockholder returns relative to future stockholder returns, though not exclusively, we identify conditions under which limitations on the deductibility of capital losses lend efficacy to unverified public disclosures that allow managers of higher value firms to separate from lower value firms in equilibrium. Although the tax asymmetry by itself may not be enough to enable separation, we show how it would nevertheless contribute to the efficiency of separation through explicitly dissipative signals. It further follows that if separation would occur by means of a dissipative signal in any event, then the tax asymmetry is welfare-enhancing. Our findings demonstrate that tax asymmetry can help resolve information asymmetry.