Capital Gains Taxes and Acquisition Activity: Evidence of the Lock-In Effect

The lock-in effect proposes that capital gains taxes represent transaction costs that increase the reservation price for security owners and, ceteris paribus, reduce trading volume. The paper investigates whether the "volume hypothesis" predicted by the lock-in effect extends to corporate acquisition activity. In particular, the paper analyzes whether aggregate corporate acquisition activity is inversely associated with shareholder capital gains tax rates. Quarterly corporate acquisition activity from 1973 through 2001 was measured using the percentage of traded firms acquired in a calendar quarter and the percentage of market value of traded firms acquired in a calendar quarter. In supplemental analysis, acquisition activity at the industry level was measured. Consistent with a lock-in effect for corporate acquisitions, a significant negative association was found between corporate acquisition activity and the capital gains tax rate whether acquisition activity was measured in the aggregate or at the industry level.