Review of Accounting Studies, 7, 319–341, 2002
2002 Kluwer Academic Publishers. Manufactured in The Netherlands.
An Empirical Examination of Tax Factors
and Mutual Funds’ Stock Sales Decisions
Pennsylvania State University
V. G. NARAYANAN
Abstract. We examine whether taxes affect stock sales by mutual funds. For certain funds, the expected amount
of a given stock sold in a given quarter is 62% greater when liquidation would trigger a capital loss equal to 1%
of the value of the portfolio than when a like-size gain would be triggered, a greater effect than is associated with
either contemporaneous excess stock returns of 50% or unexpected EPS equal to 50% of the stock price. For
growth funds, responses to tax factors are consistent from year to year, and dispositions vary with the year-to-date
Keywords: investment advisers, overhang, realized, unrealized
JEL Classiﬁcation: H20, M4
This paper investigates the inﬂuence of capital gains taxes on mutual fund managers’ deci-
sions to sell stocks. A feature of our inquiry is the data: we employ end-of-quarter positions
in speciﬁc securities held by over 300 mutual funds that ﬁled reports with CDA Investment
Technologies, Inc. over the period 1988–1992, augmented by similar data for a control
group of tax-exempt pension funds, colleges and foundations. We examine whether mu-
tual funds and tax-exempt institutions differ in their propensity to sell individual stocks
according to the institutions’ tax status, differences in capital gains triggered per dollar of
stock sold, the time remaining until the tax year-end, and the year-to-date net realized gain.
Regressions reveal that the likelihood of sale of a stock is related to the gain (or loss) realized
on sale. Moreover, institutions’ responses to tax factors vary over institution type. Signiﬁ-
cant differences across institution types remain after controlling for other variables, namely
past returns and earnings announcements, that have been shown elsewhere to correlate with
Despite the broad acceptance of the importance of taxes to investment trading strategies,
there is little documentation of the effects of taxation on stock trading decisions.
research examining the relationship between capital gains taxation and trading behavior has
examined individual investors rather than institutions.
Nevertheless, it has been established
that taxation importantly affects net-of-tax mutual fund returns: Dickson and Shoven (1993)
Address correspondence to: Smeal College of Business, Pennsylvania State University, Box 1912, University
Park, PA 16802-1912.