The effects of dividend yield and dividend policy on common stock prices and returns

This paper suggests that it is not possible to demonstrate, using the best available empirical methods, that the expected returns on high yield common stocks differ from the expected returns on low yield common stocks either before or after taxes. A taxable investor who concentrates his portfolio in low yield securities cannot tell from the data whether he is increasing or decreasing his expected after-tax return by so doing. A tax exempt investor who concentrates his portfolio in high yield securities cannot tell from the data whether he is increasing or decreasing his expected return. We argue that the best method for testing the effects of dividend policy on stock prices is to test the effects of dividend yield on stock returns. Thus the fact that we cannot tell, using the best available methods, what effects dividend yield has on stock returns implies that we cannot tell what effect, if any, a change in dividend policy will have on a corporation's stock price.     

Dividend Yields and Stock Returns: Evidence of Time Variation between Bull and Bear Markets

This study documents persistent shifts in the relationship between stock returns and dividend yields over bull and bear markets. The shift in this relationship appears as a separate effect, distinct from the January effect, and after controlling for firm size and systematic risk. After controlling for these other factors, dividend yield is positively related to return during bear markets but negatively related to return during bull markets. This time-varying relationship between dividend yield and stock return helps to explain the anomalous results of earlier studies.     

Do Tax Law Changes Influence Ex-Dividend Stock Price Behavior? Evidence from 1926 to 2005

We test the Elton and Gruber model of ex-dividend stock pricing over a period spanning all US tax law changes since 1926. Our results indicate that price drop ratios (ΔP/D) and ex-day returns are related to dividend and capital gains tax rates in the theorized manner. Consistent with tax clienteles, we also find that ex-day price movements of higher dividend yield stocks are driven more by corporate tax rates, while lower yield stocks are more influenced by personal rates. Finally, we demonstrate that the positive relationship between ΔP/D and the dividend yield becomes stronger as the tax differential | t_d− t_cg | widens.     

Optimal dividend payments in the classical risk model when payments are subject to both transaction costs and taxes

In this paper, we study optimal dividend problem in the classical risk model. Transaction costs and taxes are required when dividends occur. The problem is formulated as a stochastic impulse control problem. By solving the corresponding quasi-variational inequality, we obtain the analytical solutions of the optimal return function and the optimal dividend strategy when claims are exponentially distributed. We also find a formula for the expected time between dividends. The results show that, as the dividend tax rate decreases, it is optimal for the shareholders to receive smaller but more frequent dividend payments.     

Return,Risk, and Yield: Evidence from Ex Ante Data

The purpose of this study is to investigate the relationship between return and yield in the context of ex ante data from The Value Line Investment Survey and by examining the role of dividends as a proxy for risk. The use of ex ante data should substantially reduce the confounding of tax and information effects that has affected earlier studies. Heteroscedasticity is detected in the after-tax CAPM and found to be negatively related to yield and positively related to beta. Maximum likelihood methods are used to correct for heteroscedasticity and generate efficient coefficient estimates. Using data for each of the years 1973 through 1983, there is an overall positive relationship between expected return and yield. However, coefficient estimates of yield are highly variable from year to year.     

Stock Returns, Dividend Yields, and Taxes

Using an improved measure of a common stock's annualized dividend yield, we document that risk-adjusted NYSE stock returns increase in dividend yield during the period from 1963 to 1994. This relation between return and yield is robust to various specifications of multifactor asset pricing models that incorporate the Fama–French factors. The magnitude of the yield effect is too large to be explained by a "tax penalty" on dividend income and is not explained by previously documented anomalies. Interestingly, the effect is primarily driven by smaller market capitalization stocks and zero-yield stocks.     

Ex-Dividend Returns and the Tax Reform Act of 1986

As previously recognized, the Tax Reform Act of 1986 reduced observed ex-day returns to stocks that do not attract dividend capture trading. However, by decreasing the top corporate tax rate, and decreasing the corporate dividend income deduction, the Act also reduced the return to dividend capture by U.S. corporations. The ex-day returns for stocks that had previously attracted corporate dividend capture should therefore increase. This prediction is consistent with evidence that ex-day returns increased after the Act was implemented, among low-transaction cost, high-dividend yield stocks and among low-risk, high-dividend yield stocks.     

THE MARKET REACTION TO THE 1986 TAX OVERHAUL: A STUDY OF THE CAPITAL GAIN TAX CHANGE

The Tax Reform Act of 1986 (TRA) eliminated the favorable tax treatment on long-term capital gains in the US. Using a standard event study… CONTENTS AND ABSTRACTS 111 methodology, this paper examines daily stock return reactions to the tax overhaul. The results show that high dividend yield stocks earned a significant positive abnormal return and low yield stocks a significant negative return during the legislation period. This finding is consistent with the notion that the TRA made the market valuation of stocks shift in favor of high yield stocks.     

Changes to Income Trust Taxation in Canada: Investor Reaction and Dividend Clientele Theory

Abstract:  This paper explores the relationship between tax-induced dividend clientele theory and the recent changes to the taxation of income trusts in Canada. On October 31, 2006, the Canadian government announced the Tax Fairness Plan ( TFP ) calling for the elimination of the considerable tax advantage enjoyed by income trusts. Generally, distributions from income trusts are now taxed at rates comparable to those imposed on corporate dividends. We examine market reaction to the  TFP  to address three issues: first, whether the valuation effect of a dividend tax increase is consistent with the traditional or the new view of dividend taxation; secondly, whether the market reaction to tax increases has a differential impact on firm value that is related to the tax preferences of taxable, tax-exempt, and foreign investor tax clienteles; and thirdly, whether firms change their dividend policies in response to the preference of institutional investors (tax-based dividend policy effect) or whether institutional investors are sorting themselves across firms based on their dividend policies (investor sorting effect). Our results provide strong evidence as follows. First, the valuation effect in reaction to the  TFP  announcement is consistent with the traditional view of dividend taxation – i.e. that taxes on dividends reduce the net return to investors, increase the firm's cost of capital and lower the firm's ability to access capital markets, thereby discouraging investment and savings. Secondly, we saw that trusts with a larger percentage of their units held by tax-exempt, low-tax, and foreign investors had a higher decline in value when compared with trusts held mostly by ordinary taxable investors. These results support dividend tax clientele theory. Finally, we observed changes in institutional investor clienteles consistent with the investor sorting effect.     

Dividend growth and return predictability: A long-run re-examination of conventional wisdom

We re-examine dividend growth and return predictability evidence using 165 years of data from the Brussels Stock Exchange. The conventional wisdom holds that time-varying dividend yield is predominately explained by changes in expected returns and that expected dividend growth is only weakly forecastable. However, we find robust dividend growth predictability evidence in every time period. A lack of dividend smoothing is the most important reason for the disconnect with previous evidence. Furthermore, we find return predictability in the post-World War II period when we adjust the dividend yields for changing index composition, business cycle variation and structural breaks. This is explained by a simultaneous increase in equity duration, induced by an increasing importance of growth stocks.     

Dividend Taxes and Implied Cost of Equity Capital

We estimate firm‐level implied cost of equity capital based on recent advances in accounting and finance research and examine the effect of dividend taxes on the cost of equity capital. We investigate whether dividend taxes affect firms' cost of capital by testing the relation between the implied cost of equity capital and a measure of the tax‐penalized portion of dividend yield, which we define as the product of dividend yield and the dividend tax penalty. The results generally support the dividend tax capitalization hypothesis. We find a positive relation between the implied cost of equity capital and the tax‐penalized portion of dividend yield that is decreasing in aggregate institutional ownership, our proxy for tax‐advantaged investors. The evidence in this study adds to the understanding of the effect of investor‐level taxes on equity value.     

Taxes and dividends: The UK evidence

This paper provides empirical evidence on the simultaneous effects of both corporation and personal income taxes on dividend payment adjustments and on the behaviour of share prices on the ex-dividend dates. The results show that companies set their dividend policies to minimise their tax liability and to maximise the after-tax return of their shareholders. In particular, firms that are unable to deduct the advanced corporation tax from their tax liability are found to pay low dividends. In addition, consistent with the tax hypothesis, we find that the differential taxation of dividends and capital gains results in a decrease in ex-day share prices by significantly less than the amount of the dividend. There is no evidence of a tax-induced dividend clientele.     

The effect of personal taxes on common stock prices: The case of a Belgian tax reform

This paper analyses how a Belgian tax reform affected the relative pricing of securities with differential tax treatment of dividends. The results show that stock prices reflect their relative personal tax advantage, and the price differentials are significantly related to dividend yield.     

The ex-dividend day stock price behavior in the Chinese stock market

This paper analyzes the ex-dividend day stock price behavior in the Chinese stock market. This market allows to examine the impact of tax effects while keeping any microstructure factors constant. The findings from non-taxable stocks show that their price, on the ex-dividend day, falls by an amount that is not statistically different from the dividend. For the taxable sample, stock prices of small dividend yield stocks fall proportionally to the dividend paid. For the large dividend yield stocks, the price adjustment depends on the effective tax rate on dividend income. The overall findings are consistent with the tax hypothesis.     

The Cost of Equity Capital at the Corporate and Investor Levels Allowing a Rational Expectations Model with Personal Taxations

This paper argues that the conventional definition of the cost of equity at the corporate level is likely to be fundamentally flawed under conditions of personal taxation. A 'dimensionally consistent' definition is developed utilising the pioneering contributions of Auerbach and Elton and Gruber. Consequent benefits are straight-forward expressions for the cost of equity capital at the corporate level (for both retained earnings and new equity) as well as at the investor level (post personal tax) in terms of both the dividend discount and CAPM-type models, which are applicable to classical and imputation tax systems. A fundamental framework is thereby provided which succeeds in illuminating investor pesonal tax liabilities as they might be expected to impact on a firm's investment and related dividend policies.     

How do bond investors perceive dividend payouts?

We explore how bond investors view corporate cash distributions through dividends and how that view influences corporate cost of debt. Explaining between 45 and 67 percent of variance in credit spreads at the time of issuance, our model reveals a non-linear association between dividend payouts and investment return expected by bondholders. In particular, while bondholders view cash disbursements in small amounts as a positive signal, large dividend payouts are viewed negatively. Our results thus provide support for both the signaling hypothesis and for the agency-cost-of-debt hypothesis. The results are robust even after controlling for firm size, growth opportunities, profitability, leverage, business risk, asset tangibility, and term structure. Exploiting the 2003 dividend tax cut as an exogenous shock, we demonstrate that our results are not vulnerable to endogeneity problems. Finally, we find no evidence of corporations timing the payouts strategically to influence the cost of debt.     

Payout Policy Tax Clienteles,Ex‐dividend Day Stock Prices and Trading Behavior in Germany: The Case of the 2001 Tax Reform

This paper examines the impact of the German 2001 tax reform, where Germany switched from a full imputation system to a classical system. Theory suggests that both price drop ratios and trading volume decrease following the reform. We document a significant reduction in the valuation of net dividends–in particular for high dividend yield stocks–and weakening payout policy tax clienteles. Ex‐dividend day returns are likely to be driven by short‐term traders. Though the reform removed incentives for cross‐border dividend stripping and reduced tax heterogeneity among investors, we show that the high trading volume around ex‐dividend days persists.     

Time-varying expected small firm returns and closed-end fund discounts

This article describes the relation between closed-end funddiscounts and time-varying expected excess returns on smallfirms. The results indicate that closed-end fund discounts forecastfuture excess returns on small firms. The information in discountsis independent of that in other commonly used forecasting variablessuch as the dividend yield on the market, the default spread,and the term spread. Furthermore, the closed-end fund discountforecasts only the small firm factor return and is the onlyvariable that forecasts the small firm factor return. Additionaltests indicate that the information in discounts is relatedto expectations of future earnings growth and expectations offuture inflation. These results provide significant supportfor a rational explanation of the time-series relationship betweendiscounts and expected returns on small firms.     

AN INDIRECT TEST FOR DIVIDEND RELEVANCE

This paper provides an indirect test of dividend relevance conducted in periods that straddle the tax law changes effected by the Tax Reform Act of 1986. Using the abnormal ex-dividend day return to proxy for the tax penalty of dividends, I find a negative relation between changes in this tax penalty and changes in dividends paid. This result is consistent with corporations' equating, at the margin, the costs of dividend payout to its benefits. Hence, this is indirect evidence of dividend relevance.     

REIT Stock Prices with Inflation Hedging and Illusion

Employing dividend yield decomposition, this paper explores the inflation illusion and inflation hedging effects on REIT stock prices. Results show that changes in expected inflation explain a large share of the time series variation of the mispricing component of the dividend yield. Also, while both inflation hedging and inflation illusion effects exist for REITs, the inflation illusion effect tends to dominate the hedging effect during the 1980 to 2008 period. These results suggest that investors are unable to quickly reconcile changes in discount rates and dividend growth rates associated with inflation into stock prices. The findings also provide an alternative explanation as to why short-term REIT returns are often negatively related to expected inflation.