THE ROLE OF PRIVATE LETTER RULINGS IN TAX-FREE REORGANIZATIONS

Tax effects on target shareholder returns in corporate combinations are investigated by focusing on the role of private letter rulings (PLR), as well as other tax assurances, in tax-free and partly taxable acquisitions. Target shareholder returns are examined for differential effects associated with the various tax assurances which are found in the proxy statements associated with the combination.; The tax assurances found in the proxy statements are statements as to the nontaxability of the combination for target shareholders. They can take the form of (1) a request for a PLR from the Internal Revenue Service (IRS), (2) a counsel's opinion that the transaction is tax-free, (3) a statement that either a PLR or a counsel's opinion will be satisfactory, or (4) a statement that the firm believes the transaction is tax-free.; Excess returns for 217 target firms involved in successful acquisitions during the period 1978-1986 are calculated. For all sample firms, there was a significantly positive excess return for a three-day window around the proxy statement mailing date. Firms stating that either a PLR or a counsel's opinion is satisfactory had the largest returns during this period while firms requesting only a PLR had negative returns. The difference between these two groups was significant. Firms requesting PLRs had the largest returns around the Wall Street Journal's announcement of the merger. For the interim period between the merger announcement date and the shareholder meeting, firms requesting rulings had a return of {dollar}-{dollar}0.002. Finally, returns for the entire merger period averaged 0.22 for all firms, and there were no significant differences between the four subgroups.; Results also suggest that firms which request rulings are smaller than other sample firms and also have a significantly higher level of ownership by officers, directors, and shareholders owning more than five percent of the corporation. As such, these shareholders appear able to both influence the merger negotiations to ensure the best price for their stock and wait the additional period necessary to receive the PLR from the IRS.