Thomas J Chemmanur, S Abraham Ravid
ABSTRACT We develop a model of corporate myopia in which the
interaction between asymmetric information and short-term trading by the
firm's equity holders induces firm managers to undertake a short-term projects
rather than long-term projects, which are intrinsically more valuable.
In this setting, we analyze the impact on a reduction in the capital gains
tax rate on project selection. We show that a capital gains tax cut for
investors who hold equity in the firm
beyond a certain length of time can induce optimal project selection
by firm mangers: an across-the-board tax cut, on the other hand, has no
such impact. We characterize the long-term capital gains tax rate which
eliminates corporate myopia. We demonstrate that a long-term capital gains
tax cut does not create a bias toward inefficient long-term projects in
situations where it is the short-term project that is intrinsically more
valuable. We further show that, under certain conditions, reducing the
long-term capital gains tax rate to the level required to eliminate myopic
investment behavior can also lead to an increase in government tax revenues.
Ravid: (973) 353-5540
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