A Theory of Dividends Based on Tax Clienteles

This paper explains why some firms prefer to pay dividends rather than repurchase shares. When institutional investors are relatively less taxed than individual investors, dividends induce "ownership clientele" effects. Firms paying dividends attract relatively more institutions, which have a relative advantage in detecting high firm quality and in ensuring firms are well managed. The theory is consistent with some documented regularities, specifically both the presence and stickiness of dividends, and offers novel empirical implications, e.g., a prediction that it is the tax difference between institutions and retail investors that determines dividend payments, not the absolute tax payments.     

A股税收客户群效应及除息日税负效应实证研究

本文分析了2002—2007年A股市场的纯现金红利分红数据,检验了这一期间在除息日套利的可能性,证实该期间市场存在除息日股价的税负效应,以及税收客户群效应。说明A股市场不同类的投资者对分红具有不同的偏好,上市公司应制定合适的股利政策以最大化股东财富。早期的关于国内市场的研究得到市场不存在税收客户群效应的结论,前后对比说明随着国内证券市场的发展,投资者更趋于理性。     

Inside shareholders’ effective tax rates and dividends

Using information collected from the Swedish tax authorities, we calculate insiders’ actual effective tax rates on dividends. With this unique dataset, we find a significant negative cross-sectional relationship between insiders’ effective tax rates and dividend payout. This result is consistent with a tax-induced clientele effect for dividends. We also look at the impact of large block trades on dividends. We find that when insiders with zero effective taxes sell blocks, subsequent dividend payments are significantly more likely to decrease. This provides evidence that large shareholders are adjusting dividends for their individual tax situations.     

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.     

Dividend policy and permanence of earnings

We examine managers’ adjustment of dividends to information about earnings. We base our analysis on a ‘permanent earnings’ model of dividend behavior, which implies that dividends are changed primarily in response to permanent changes in earnings; transitory earnings changes have little or no effect on dividends. Within the permanent earnings framework, the permanent component of earnings may be the predominant factor affecting dividend payouts, or it may be one of the important factors affecting dividends. In the former case earnings and dividends are co-integrated; in the latter they are not. Using a sample of 337 firms over the 40 year period from 1950–1989, we find the data to be strongly consistent with the permanent earnings model. We also find that the data are more consistent with a model that relates dividend and earnings changes rather than levels. Thus, we conclude that earnings and dividends are not co-integrated. This contrasts with the implicitly co-integrated (levels) dividend model of Lintner (1956), and indicates that factors other than the permanent component of earnings, such as tax policy, clientele effects, transaction costs, etc. may have a significant impact on the long-run behavior of dividends.     

EX-DIVIDEND DAY PRICE CHANGES AND IMPLIED TAX RATES: AN EVALUATION

The ratio of price changes to dividends is sometimes used to assess personal tax rates and detect tax clientele for dividends. It is suggested here that the model is unable to detect possible tax effects, given the sample sizes available to most researchers.     

Capital gains tax,managed funds and the value of dividends: The case of New Zealand

The taxation of capital gains for Managed Investment Funds in New Zealand was abolished in October 2007, putting these entities on a similar footing to private investors. Prior to this change most private investors were not taxed on capital gains from investments in New Zealand companies, whereas Managed Funds were taxed on these gains. New Zealand company dividends carry imputation tax credits and thus had a tax advantage for Managed Funds before October 2007. After the change the value of dividends relative to capital gains declined substantially for Managed Funds. The evidence is that the market value of the dividends, particularly for high dividends, also declined substantially subsequent to the tax change.     

Taxes,International Clienteles and the Value of ADR Dividends

An alternative approach to valuing dividends is developed and applied to American Depositary Receipts (ADRs) on Australian stocks. The values of ADR dividends are estimated from the period when, due to different ex‐dividend dates, the ADRs and their underlying stocks trade with differential dividend entitlements. Australian ADR dividends are valued at less than their face value and the dividends on the underlying stocks are valued at more than their face value. This suggests that ADR dividends are priced by a clientele of US investors placing little value on the imputation tax credits attached to the dividends and that a clientele of Australian resident investors, who obtain value from imputation tax credits, price the dividends on the underlying stock.     

The Dividend Puzzle: An Australian Solution?

In the latter half of the 1980s, Australia made changes to its taxation law which affected the economics of asset ownership, particularly share ownership. The first of these changes was the introduction in September 1985 of a general tax on capital gains. The second was the virtual abolition of company tax through the introduction of tax imputation. In this changed tax environment it is argued that where the payment of franked dividends is concerned, there is an optimal dividend policy: companies should pay dividends to the limit of their franking account balances. In the case of unfranked dividends it is argued that there is no optimal policy and that Miller and Modigliani's clientele theory applies. The paper describes an analysis of the dividend payout ratios of the top 422 listed Australian companies from 1982 to 1990.     

Are ex‐day dividend clientele effects dead? Dividend yield versus dividend size

We devise an approach to determine whether market microstructure or taxes influence ex-dividend behavior. We find that microstructure effects of automated limit order adjustments strongly influence ex-day prices for dividends less than or equal to a tick. For these dividends, after controlling for dividend size, we find no relation between price-drop-to-dividend ratio and dividend yield. For larger dividends, both microstructure and tax effects are found: Consistent with the microstructure story we find that between ticks, as dividend sizes increase (hence dividend yields increase), price-drop-to-dividend ratios decrease. However, consistent with the tax clientele hypothesis, when dividend size is fixed, a positive relation between price-drop-to-dividend ratio and yield is still seen.     

Taxes and dividend clientele: Evidence from trading and ownership structure

Although dividend clientele have been studied over several decades, their existence remains controversial. We study the interaction of dividends and taxes by exploiting a unique dataset from Taiwan, where the capital gains tax is zero. We find strong evidence of a clientele effect. Agents subject to high rates of taxation on dividends tend to hold stocks with lower dividends and sell (buy) stocks that raise (lower) dividends. Agents in lower tax brackets behave in the opposite manner. After legalization of repurchases in 2000, firms with higher concentrations of more heavily taxed shareholders were more apt to begin repurchase programs.     

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.     

The Informativeness of Dividends and Associated Tax Credits

This paper investigates the informativeness of dividends and the associated tax credits with respect to earnings persistence. After confirming that dividend‐paying firms have more persistent earnings than non‐dividend‐paying firms, we show that the taxation status of the dividend is also important. Firms that pay dividends with a full tax credit attached have significantly more persistent earnings than firms that pay dividends which carry no associated tax credit. Consistent with higher levels of tax credits identifying more mature firms, those paying dividends with full tax credits have significantly less persistent losses than firms that pay dividends with only partial tax credits. Further, market pricing tests confirm that the incremental information in dividends and tax credits contributes to reductions in market mispricing of the persistence of earnings and earnings components. Our results are robust to alternative model specifications and controlling for dividend size and firm age.     

Determinants of Corporate Dividend Policy: A Factorial Analysis

This paper re-examines the dividend policy issue by conducting a simultaneous test of the alternative explanations of corporate payout policy using a two-step procedure that involves factor analysis and multiple regression. Several new proxies for theoretical attributes that have appeared in the literature are introduced, including the role of managerial dimensions in determining dividend policy. Strong support is found for the transaction cost/residual theory of dividends. pecking order argument, and the role of dividends in mitigating agency problems. Strong support is also found for the role of managerial consideration in affecting the firm's payout policy; specifically, firms that maintain stable dividend policies and firms that enjoy financial flexibility pay higher dividends. The results appear to support the tax clientele argument.     

Why do firms pay dividends? International evidence on the determinants of dividend policy

In the US, Canada, UK, Germany, France, and Japan, the propensity to pay dividends is higher among larger, more profitable firms, and those for which retained earnings comprise a large fraction of total equity. Although there are hints of reductions in the propensity to pay dividends in most of the sample countries over the 1994–2002 period, they are driven by a failure of newly listed firms to initiate dividends when expected to do so. Dividend abandonment and the failure to initiate by existing nonpayers are economically unimportant except in Japan. Moreover, in each country, aggregate dividends have not declined and are concentrated among the largest, most profitable firms. Finally, outside of the US there is little evidence of a systematic positive relation between relative prices of dividend paying and non-paying firms and the propensity to pay dividends. Overall, these findings cast doubt on signaling, clientele, and catering explanations for dividends, but support agency cost-based lifecycle theories.     

A note on transaction costs and the interpretation of dividend drop‐off ratios

In a recent edition of this Journal, Bartholdy and Brown (1999) presented an analysis of the ex‐dividend share price behaviour of shares listed on the New Zealand Stock Exchange. The authors conclude that their results are consistent with the tax clientele effect (driven by long‐term investors) and that there is little or no support for the short‐term trading hypothesis. Our purpose is to highlight the importance of transaction costs in analyses such as Bartholdy and Brown's. We argue that their results have an alternative interpretation because their analysis excludes the impact of transaction costs. We extend their model to include transaction costs and show that their results are not necessarily inconsistent with the short‐term trading hypothesis. A critical point of our analysis is that, in the presence of transaction costs, the equilibrium drop‐off ratio for dividend strip traders will be less than one, and, in some cases, can be less than the equilibrium drop‐off ratio for long‐term investors.     

Dividend payout and executive compensation: theory and evidence from New Zealand

Using a model based on Bhattacharyya (2007), we predict a positive (negative) relationship between the earnings retention ratio (dividend payout ratio) and managerial compensation. We use tobit regression to analyse data for New Zealand firms' dividend payouts over the period 1997–2015 and find results consistent with Bhattacharyya (2007). These results hold when the definition of payout is modified to incorporate both common dividends and common share repurchases. Our results indicate that corporate dividend policy among New Zealand firms is perhaps best understood by considering the dividend payout ratio, rather than the level of, or changes in, cash dividends alone.     

Tax reform and payout policy: Do shareholder clienteles or payout policy adjust?

Changes in taxation of corporate dividends offer excellent opportunities to study dividend clientele effects. We explore payout policies and ownership structures around a major tax reform that took place in Finland in 2004. Consistent with dividend clienteles affecting firms' dividend policy decisions, we find that Finnish firms altered their dividend policies based on the changed tax incentives of their largest shareholders. While firms adjust their payout policies, our results also indicate that ownership structures of Finnish firms also changed around the 2004 reform, consistent with shareholder clienteles adjusting to the new tax system.     

Effects of investor tax heterogeneity on stock prices and trading behaviour around the ex-dividend day: the case of Australia

Using a sample of Australian stocks during the 1996–2014 period, this study examines how tax heterogeneity between domestic and foreign investors affects trading behaviour and stock prices around the ex-dividend day. Domestic investors prefer dividends and tend to buy stocks cum-dividend and sell them ex-dividend whereas foreign investors tend to trade in the opposite direction. Abnormal trading turnover increases with tax heterogeneity. Moreover, stocks with a larger domestic investor base are associated with a higher price drop-off ratio on the ex-dividend day and higher market value of franking credits. Overall, our findings support the dynamic dividend clientele hypothesis.     

Stock Dividend Announcement Effects in an Imputation Tax Environment

A key question in asset pricing is the extent to which tax effects are passed through market prices or are capitalised in them. New Zealand stock dividends provide a useful window into this debate because of (1) the existence of both taxable and non-taxable stock dividends, and (2) the particular form of imputation tax system which allows the full pass through of corporate taxes to the investor on the proportion of profits which are distributed either as cash or taxable stock dividends. We present evidence that investors value future tax benefits associated with imputation tax credits.