Taxation Influences upon the Market in Venture Capital Trust Stocks: Theory and Practice

Individuals investing in a Venture Capital Trust IPO listed on the London Stock Exchange receive a number of conditional tax incentives; the time related nature of the conditions can create a “lock in effect”. By deriving a dynamic model of the value of these incentives we examine how they influence investors’ pricing and trading decisions. This contributes to the ongoing tax capitalisation debate in two ways: first, in calculating the magnitude of the lock in effect without reference to underlying shareholder records; second, in providing an approach which can be used in thinly traded quote-driven markets – by focusing on changes in the bid-ask spread, as opposed to mid-prices. Our results confirm the existence of tax capitalisation and tax induced trading consistent with changes in the present value of the incentives. Address for correspondence: Professor Kevin Holland and Dr Mark Rhodes School of Management & Business, University of Wales, Aberystwyth Cledwyn Building, Penglais, Aberystwyth Ceredigion, SY23 3DD, Wales, UK e-mail: [email protected] [email protected] Acknowledgements We are grateful to Dan Dhaliwal, David Gwilliam, Lil Mils, Kaye Newberry and seminar participants at, the School of Management and Business, University of Wales, Aberystwyth and Cardiff University for helpful comments; to Xenia Holstein for assistance with data collection; and to a number of Venture Capital Trust advisors, fund managers and market makers for discussions and comment. * Senior Lecturer in Accounting and Finance, School of Business and Economics, University of Exeter, Streatham Court, Rennes Drive, Exeter EX4 4PU.([email protected].)