Inventory Rules, Taxation and Institutions' Trading Decisions
Stanford University Research Paper Number 1274
Posted: 2 Sep 1999
Date Written: July 1994
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: Suggested Citation