Market expectations of the effects of the Tax Reform Act of 1986 on banking organizations^* *...

Title full: Market expectations of the effects of the Tax Reform Act of 1986 on banking organizations^* * Correspondence address: School of Business, University of Wisconsin, 1155 Observatory Drive, Madison, WI, U.S.A. We would like to thank Guy Charest, George Kaufman, Jim Pappas, George Pennacchi, Tony Saunders, Rex Thompson and two anonymous referees for their valuable comments and suggestions. Partial financial support from the Chair in Insurance at Laval University is gratefully acknowledged by the second author. This study investigates market expectations regarding the effect of the Tax Reform Act of 1986 on the banking industry. The evidence shows that overall the tax reform did not adversely affect the stocks of banking institutions. The findings suggest that overall banking organizations were expected to largely mitigate any negative effects of the tax reform on their cash flow by rebalancing and/or repricing their portfolios of assets and liabilities. The most significant provision of the new act was the limitation on foreign tax credits. Interestingly, the markets did not expect any adverse valuation effects from the recapture of loan-loss reserves or the elimination of the interest deductibility for carrying tax-exempt securities.