As financial engineering becomes more sophisticated, taxing income from capital becomes increasingly difficult. We offer the first empirical study of a high profile strategy known as "tax-free hedging," which offers economic benefits of a sale without triggering tax. We explore nontax costs that taxpayers face when hedging by issuing so-called "DECS," "PHONES," and other publicly-traded exchangeable securities. Focusing on 61 transactions between 1993 and 2001, we shed light on why taxpayers might prefer to hedge through private "over-the-counter" transactions: An offering of exchangeable securities is announced in advance and implemented all at once, triggering an almost 5 percent decline in the underlying stock price before the hedge is implemented.
William M. Gentry & David M. Schizer,
Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities,
Washington University Journal of Law & Policy, Vol. 13, p. 9, 2003; National Tax Journal, Vol. 56, p. 167, 2003; National Bureau of Economic Research Working Paper No. 9243
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/2487