The effects of capital gains taxes on CEO stock ownership and subsequent firm performance

This study examines the association between the Taxpayer Relief Act of 1997 (TRA97) capital gains tax rate reduction and the level of chief executive officer (CEO) equity ownership. In addition, the relationship between the level of CEO ownership and their firms' stock price performance during the following year is investigated. A large sample of CEOs employed in Standard and Poor's (S&P) 1500 firms from 1992 to 2003 is analyzed. The empirical tests are conducted using time series cross-sectional fixed effects regression models of CEO ownership levels that are primarily based on agency theory. The findings indicate that (i) CEO ownership increased following the TRA97, (ii) the capital gains tax rate reduction decreased their sensitivity to future firm performance, and (iii) CEO ownership is increasing with their firms' subsequent abnormal returns and decreasing with current overall market performance. This last result suggests that CEO ownership is dependent on the availability of other attractive investment choices. In sum, the results suggest that the level of CEO ownership is inversely related to the capital gains tax rate and that this effect varies with the abnormal returns of the firm during the following year.