Capital Gains Taxation and the Cost of Capital: Evidence from Unanticipated Cross-Border Transfers of Tax Bases

In a cross-border takeover, the tax base associated with future capital gains is transferred from target shareholders to acquirer shareholders. Cross-country differences in capital gains tax rates enable us to estimate the discount in the takeover price on account of future capital gains. The estimation suggests that a one percentage point increase in the capital gains tax rate reduces the valuation of new equity by 0.136%. The implied average effective tax rate on capital gains is 4.57%, indicating that capital gains taxation is a significant cost to firms when raising new equity capital. Apart from the taxation of future capital gains, we also find that takeover prices are affected by capital gains taxation resulting from the accelerated realization of past capital gains by target shareholders.