NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities

William Gentry, David M. Schizer

NBER Working Paper No. 9243
Issued in September 2002
NBER Program(s):   AP   PE

As financial engineering becomes more sophisticated, taxing income from capital becomes increasingly difficult. A crucial issue for tax policymakers, then, is the ease or difficulty of implementing tax-advantaged transactions 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 one method of hedging, in which the taxpayer issues publicly-traded exchangeable securities, known by acronyms such as DECS and PHONES. We focus on such offerings between 1992 and 2001, identifying 61 transactions that account for $24 billion in proceeds. Using these publicly-available data, we offer empirical evidence about various frictions that might discourage taxpayers from hedging with exchangeable securities. In so doing, we shed light on why taxpayers might prefer to hedge through private over-the-counter' transactions with derivatives dealers. The main reason is that an offering of exchangeable securities is announced in advance and implemented all at once, triggering an almost four percent decline in the underlying stock price before the hedge is implemented.

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Document Object Identifier (DOI): 10.3386/w9243

Published: Gentry, William M. and David M. Schizer. "Frictions And Tax-Motivated Hedging: An Empirical Exploration Of Publicly-Traded Exchangeable Securities," National Tax Journal, 2003, v56(1,Supp), 167-195.

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