Free Cash Flow (FCF) agency conflicts exist when managers divert cash flow for private benefits. We identify the impact of unobservable FCF conflicts on firm policy using a structural approach. Measurement equations are constructed based on observable managerial choices: payout policy changes and personal portfolio decisions around exogenous tax rate changes. We find that FCF agency conflicts cause (i) under-leverage, leading to higher corporate taxes and (ii) under-investment in PP&E, leading to slower firm growth. Capital markets recognize FCF conflicts and discount such firms. Finally, firms with (i) large institutional holdings or (ii) better-aligned executive compensation, suffer less from FCF agency conflicts.

Agency Costs of Free Cash Flow

Executive SummaryThis paper provides preliminary evidence on behavioral responses to taxation around the 2013 tax increase that raised top marginal tax rates on capital income by about 9.5 points and on labor income by about 6.5 points. Using published tabulated tax statistics from the Statistics of Income division of the IRS, we find that reported top 1% incomes were significantly higher in 2012 than in 2013, implying a large short-run elasticity of reported income with respect to the net-of-tax rate in excess of one. This large short-run elasticity is due to income retiming for tax avoidance purposes and is particularly high for realized capital gains and dividends, and highest at the very top of the income distribution. However, comparing 2011 and 2015 top incomes uncovers only a small medium-term response to the tax increase as top income shares resumed their upward trend after 2013. Overall, we estimate that at most 20% of the projected tax revenue increase from the 2013 tax reform is lost through be...

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Taxing the Rich More: Preliminary Evidence from the 2013 Tax Increase

The abolition of the favorable tax treatment of long term capital gains forced investors to reassess traditional year-end trading strategies used to manage tax liabilities This study compares with year-end trading behavior in previous years with that observed at the end of 1986 Traditional strategies involve selling both short and long term losers and holding short and long term winners Our results affirm previous findings concerning tax induced trading at year end However, for 1986, we find that the anticipated tax code changes had a powerful effect on trading behavior Compared to previous years, relative trading volume was considerably higher in December of 1986 for long term winners and lower for long term losers Additional results indicate that traditional patterns of trading induced by short term capital gains and losses were also altered substantially in 1986

Tax Induced Trading: The Effect of the 1986 Tax Reform Act on Stock Market Activity

This paper examines how high-income taxpayers reacted to major tax legislation that affected incentives for realizations of capital gains, the form of compensation, type of investments, and the cho...

Reactions of High-Income Taxpayers to Major Tax Legislation

Executive SummaryDonor-Advised Funds (DAFs) are now a major source of charitable donations in the United States, responsible for 1 in 10 dollars donated to charity in 2015. In 2016, Fidelity Charit...

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The Benefits and Costs of Donor-Advised Funds

Exploiting the increase in personal tax rates due to the American Taxpayer Relief Act and Healthcare Act, we identify tax-minded executives who exhibit a preference for personal tax savings. We find that 2,281 top executives strategically realized their built-in capital gains prior to the tax hikes to save nearly $741 million in personal taxes in 2012. These executives also save their shareholders taxes and save their firms cash taxes. Specifically, their firms distributed $8 billion in special and accelerated dividends in 2012, which saved shareholders nearly $700 million in taxes. Further, each tax-minded executive reduces a firm’s long-run cash effective tax rate by 0.43%.

Andreya M. Perez-Silva

Papers

Tax-Minded Executives and Corporate Tax Strategies: Evidence from the 2013 Tax Hikes