Capital gains tax, supply-driven trading and ownership structure: Direct evidence of the lock-in effect

This study investigates the effect of differential capital gains tax rates on investor trading and share prices in a unique market setting that facilitates the resolution of conflicting prior evidence of holding period tax incentives. In particular, we examine whether the concessionary tax treatment of long-term capital gains increases the supply of shares that qualify for long-term status, thereby causing downward price pressure. We find evidence of abnormal seller-initiated trading following the 12-month anniversary of listing for IPO firms that appreciate in price ( winners ) and report no such evidence for firms that decline in price ( losers ). Consistent with the tax concessions being greater for individual than institutional investors, we report that abnormal seller-initiated trading is mitigated by higher levels of ownership by institutional investors. We also report limited evidence, for winners, of declining share prices upon qualifying for long-term tax status.