The Effects of the Capital Gains Tax Rate and Expectations of Subsequent Firm Performance on CEO Stock Ownership

This study examines the relationship 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 equity ownership and CEO expectations of future stock prices is investigated. Corporate scandals in recent years have increased institutional investors’ advocacy of CEO stock ownership, which investors believe will align CEO interests with those of stockholders. Prior research on the role of taxes in equity-based compensation has focused on stock option exercises, but has not studied how a tax rate change affects CEO ownership. The findings from time-series cross-sectional fixed-effects regression models of ownership levels indicate 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.