The Holding Period Distinction of the Capital Gains Tax

United States tax law distinguishes between short-term and long-term capital gains. By taxing long-term gains at a lower rate the law creates an incentive for investors to postpone the realization of short-term gains. This study examines the lock-in effect induced by the differential tax treatment of long- and short-term gains. Analysis of data on corporate stock transactions from 1973 suggests that the lock-in effect is large and, thus, causes investors to alter their investment portfolios. The existence of such an effect is inefficient and results in a reduction in capital market efficiency. The inefficiency might be justified if there were convincing reasons which supported the existence of the holding period distinction. It is commonly argued, for instance, that eliminating the distinction would encourage short-term speculation at the expense of long-term commitment to capital. It is also claimed that this would result in a loss of revenue to the government. This study relies on IRS data and simulations using the NBER-TAXSIM file to examine the validity of these arguments. The results of this study suggest that the holding period distinction is not very effective in deterring speculation and does not increase government revenues; in fact, it may decrease them.

The Staying Power of Leveraged Buyouts

This paper documents the organizational status over time of 183 large leveraged buyouts (LBOs) completed between 1979 and 1986. As of August 1990, 63% of the LaOs are privately owned, 14% are independent public companies, and 23% are owned by other public companies As time since the LBO increases, the percentage of LBOs that have returned to public ownership increases. The (unconditional) median time LBOs remain private equals 6.70 years. This evidence suggests that the majority of LBO organizations are neither short-lived nor permanent. In addition the moderate fraction of LBOs assets owned by other (potentially related) companies implies that asset sales play a role in, but are not the primarily force motivating LBO transactions.

Private Equity Performance: Returns, Persistence and Capital

This paper investigates the performance of private equity partnerships using a data set of individual fund returns collected by Venture Economics. Over the sample period, average fund returns net of fees approximately equal the S\&P 500 although there is a large degree of heterogeneity. Returns persist strongly across funds raised by individual private equity partnerships. Better performing funds are more likely to raise follow-on funds and raise larger funds than funds that perform poorly. This relationship is concave so that top performing funds do not grow proportionally as much as the average fund. Finally, market entry in private equity is cyclical. Funds (and partnerships) started in boom times are less likely to raise follow-on funds, suggesting that these funds subsequently perform worse. Several of these results differ markedly from those for mutual funds.

Investment-Cash Flow Sensitivities are not Valid Measures of Financing Constraints

Kaplan and Zingales [1997] provide both theoretical arguments and empirical evidence that investment-cash flow sensitivities are not good indicators of financing constraints. Fazzari, Hubbard and Petersen [1999] criticize those findings. In this note, we explain how the Fazzari et al. [1999] criticisms are either very supportive of the claims in Kaplan and Zingales [1997] or incorrect. We conclude with a discussion of unanswered questions.

The State of U.S. Corporate Governance: What's Right and What's Wrong?

The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies. Those failures and criticisms, in turn, have served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (new governance guidelines from the NYSE and NASDAQ). In this paper, we consider two questions. First, is it clear that the U.S. system has performed that poorly; is it really that bad? Second, will the changes lead to an improved U.S. corporate governance system? We first note that the broad evidence is not consistent with a failed U.S. system. The U.S. economy and stock market have performed well both on an absolute basis and relative to other countries over the past two decades. And the U.S. stock market has continued to outperform other broad indices since the scandals broke. Our interpretation of the evidence is that while parts of the U.S. corporate governance system failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. We then consider the effects that the legislative, regulatory, and market responses are likely to have in the near future. Our assessment is that they are likely to make a good system better, though there is a danger of overreacting to extreme events.

Characteristics, Contracts, and Actions: Evidence from Venture Capitalist Analyses

We study the investment analyses of 67 portfolio investments by 11 venture capital (VC) firms. VCs consider the attractiveness and risks of the business, management, and deal terms as well as expected post-investment monitoring. We then consider the relation of the analyses to the contractual terms. Greater internal and external risks are associated with more VC cash flow rights, VC control rights; greater internal risk, also with more contingencies for the entrepreneur; and greater complexity, with less contingent compensation. Finally, expected VC monitoring and support are related to the contracts. We interpret these results in relation to financial contracting theories.

The State of Corporate Governance 2004

The U.S. corporate governance system has recently been heavily criticized, largely as a result of failures at Enron, WorldCom, Tyco and some other prominent companies. Those failures and criticisms, in turn, have served as catalysts for legislative change (Sarbanes-Oxley Act of 2002) and regulatory change (new corporate governance listing standards from the NYSE and NASDAQ). In this paper, we consider two questions. First, is it clear that the U.S. system has performed that poorly; is it really that bad? Second, will the changes lead to an improved U.S. corporate governance system. We first note that the broad evidence is not consistent with a failed U.S. system. The U.S. economy and stock market have performed well both on an absolute basis and relative to other countries over the past two decades. And the U.S. stock market continued to outperform other broad indices after the scandals broke. Our interpretation of the evidence is that while parts of the U.S. corporate governance system failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. We then consider the effects that the legislative, regulatory, and market responses are likely to have in the near future. Our assessment is that they are likely to make a good system better, though there is a danger of overreacting to extreme events.Technology and Industry, Regulatory Reform

Leveraged Buyouts and Private Equity

We describe and present time series evidence on the leveraged buyout/private equity industry, both firms and transactions. We discuss the existing empirical evidence on the economics of the firms and transactions. We consider similarities and differences between the recent private equity wave and the wave of the 1980s. Finally, we speculate on what the evidence implies for the future of private equity.PrivateEquity

Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts

In this paper, we compare the characteristics of real world financial contracts to their counterparts in financial contracting theory. We do so by conducting a detailed study of actual contracts between venture capitalists (VCs) and entrepreneurs. We consider VCs to be the real world entities who most closely approximate the investors of theory. (1) The distinguishing characteristic of VC financings is that they allow VCs to separately allocate cash flow rights, voting rights, board rights, liquidation rights, and other control rights. We explicitly measure and report the allocation of these rights. (2) While convertible securities are used most frequently, VCs also implement a similar allocation of rights using combinations of multiple classes of common stock and straight preferred stock. (3) Cash flow rights, voting rights, control rights, and future financings are frequently contingent on observable measures of financial and non-financial performance. (4) If the company performs poorly, the VCs obtain full control. As company performance improves, the entrepreneur retains / obtains more control rights. If the company performs very well, the VCs retain their cash flow rights, but relinquish most of their control and liquidation rights. The entrepreneur's cash flow rights also increase with firm performance. (5) It is common for VCs to include non-compete and vesting provisions aimed at mitigating the potential hold-up problem between the entrepreneur and the investor. We interpret our results in relation to existing financial contracting theories. The contracts we observe are most consistent with the theoretical work of Aghion and Bolton (1992) and Dewatripont and Tirole (1994). They also are consistent with screening theories.