Capital Gains Taxes, Irreversible Investment, and Capital Structure.

This paper studies the corporate policy distortions caused by realization-based capital gains taxation at the personal level in a dynamic trade-off theory model. The Lock-in effect of embedded capital gains creates severe conflicts of interest between incumbent and new investors. The firm's optimal policy exhibits path-dependency and non-stationarity, since the taxe basis of the firm's owners is a valuable conditioning variable for corporate decisions. Ex-ante identical firms follow very different investment and financial policies depending on their stock price evolution. Firms delay irreversible investment further the lower tax basis of their owners falls. The reason is the investment hedge provided by personal tax loss offsets weakens as investors reset their basis. Capital gains taxation also creates incentives to time equitzy issues. Firms employ more equity in their capital structure the higher the stock price-to-basis ratio, since locked-in investors with out-of-the-money tax timing options value the firm less than the market. The value gain from conditioning on the owner's tax basis is substantial. Using simulated data I show the combined effects are consistent with recent empirical evidence on the relation between leverage, Tobin's Q, and past performance.Capital Gains Taxation, Real Options, Capital Structure, Trade-off Theory, Market Timing.

Power law Polya’s urn and fractional Brownian motion

We introduce a natural family of random walks S[subscript n] on Z that scale to fractional Brownian motion. The increments X[subscript n] := S[subscript n] − S[subscript n]−1 ∈ {±1} have the property that given {X[subscript k] : k < n}, the conditional law of X[subscript n] is that of X[subscript n−k[subscript n]] , where k[subscript n] is sampled independently from a fixed law μ on the positive integers. When μ has a roughly power law decay (precisely, when μ lies in the domain of attraction of an α-stable subordinator, for 0 < α < 1/2) the walks scale to fractional Brownian motion with Hurst parameter α + 1/2. The walks are easy to simulate and their increments satisfy an FKG inequality. In a sense we describe, they are the natural “fractional” analogues of simple random walk on Z.National Science Foundation (U.S.) (Grant DMS-0403182)National Science Foundation (U.S.) (Grant DMS-0645585)National Science Foundation (U.S.) (Grant OISE-07-30136