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 target valuation on account of future capital gains. We estimate that a 1 percentage point increase in the capital gains tax rate reduces the value of equity by around 0.3%, which suggests that the capital gains tax significantly raises firms’ cost of capital. Furthermore, we find that the implied capital gains tax burden is higher at times of high economic growth and low stock market valuation.

This paper is the first to show that financial institutions may be effectively undercapitalized as a result of incomplete consolidation of minority ownership. Using two approaches – consolidating the minority-owned affiliates with the parent or deducting equity investments in minority ownership from the parent's capital – we find that the effective capitalization ratios of small US bank holding companies (BHCs) are substantially lower than the reported ratios. Empirical evidence suggests that the effectively lower capitalization ratios are associated with higher riskiness at the BHC level. Capital adjustments following pro forma consolidation better capture the additional risks than capital adjustments in the form of equity deductions for investments in minority-owned affiliates. These findings have important implications for the regulation of bank capital.

We find that shareholder-friendly corporate governance is associated with higher stand-alone and systemic risk in the banking sector. Specifically, shareholder-friendly corporate governance results in higher risk for larger banks and for banks that are located in countries with generous financial safety nets as banks try to shift risk toward taxpayers. We confirm our findings by comparing banks to nonfinancial firms and examining changes in bank risk around an exogenous regulatory change in governance. Our results underline the importance of the financial safety net and too-big-to-fail guarantees in thinking about corporate governance reforms at banks.