Mutual funds' capital gains lock-in and earnings management

• Main Authors: Dimmock, Stephen G., Feng, Fan, Zhang, Huai
• Other Authors: Nanyang Business School
• Format: Article
• Language: English
• Published: 2024
• Subjects: Business::Finance; Earnings Quality; Earnings Management
• Online Access: https://hdl.handle.net/10356/172930
• Institution: Nanyang Technological University

Capital gains taxation creates a lock-in effect, increasing investors' incentives to monitor and decreasing portfolio firms' incentives to cater to short-term investors. We show a negative relation between lock-in and portfolio firms' earnings management, and this relation is stronger for capital gains held by tax-sensitive investors. Further, the relation between lock-in and earnings management is stronger when the capital gains tax rate is higher. We show that locked-in funds vote against management and against audit committee members' reappointment following earnings management. Locked-in funds are less likely to exit a position following disappointing earnings announcements, reducing firms' incentive to manage earnings.