Inventory Rules, Taxation and Institutions' Trading Decisions

Stanford University Research Paper Number 1274

Posted: 2 Sep 1999

See all articles by Steven J. Huddart

Steven J. Huddart

Pennsylvania State University, University Park - Department of Accounting

V. G. Narayanan

Harvard University - Accounting & Control Unit

Date Written: July 1994

Abstract

This paper examines whether the trading decisions of institutional investors can be explained in part by the effects of taxation on portfolio returns. We find that advisers managing portfolios on behalf of persons who are taxable entities are 26 percent less likely to sell securities that trigger large capital gains than securities that trigger no capital gains. Also, tax considerations seem to weigh more heavily in trading decisions later in the fiscal year. The decision to sell a particular security appears to depend on the cumulative gain or loss realized by the institutions so far in the tax year. Tax-exempt institutional investors do not exhibit these tendencies. Surprisingly, all institutions are less likely to sell securities that would trigger a large loss. The inventory flow assumption adopted for tax purposes affects the size of the gain or loss realized in the sale of a block of stock. Consistent with tax planning, a HIFO (highest in, first out) inventory rule is most significant for taxable institutions; a FIFO inventory rule is most significant for non-taxable institutions.

JEL Classification: G23

Suggested Citation

Huddart, Steven J. and Narayanan, V. G., Inventory Rules, Taxation and Institutions' Trading Decisions (July 1994). Stanford University Research Paper Number 1274, Available at SSRN: https://ssrn.com/abstract=5445

Steven J. Huddart (Contact Author)

Pennsylvania State University, University Park - Department of Accounting ( email )

University Park, PA 16802-3603
United States
814-863-0448 (Phone)

HOME PAGE: http://directory.smeal.psu.edu/sjh11

V. G. Narayanan

Harvard University - Accounting & Control Unit ( email )

Soldiers Field
Boston, MA 02163
United States
617-495-6359 (Phone)
617-496-7363 (Fax)

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