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.     

Dividends,taxes, and common stock prices: The ex-dividend day behavior of common stock prices before the income tax

This study examines the ex-dividend day behavior of common stock prices before the enactment of the federal income tax. On ex-dividend days during the pre-tax period, stock prices fell, on average, by the full amount of the dividend. The data are consistent with the hypothesis that (i) investors in the pre-tax period value dividends and capital gains as perfect substitutes and (ii) the differential taxation of dividends and capital gains has since caused investors to discount the value of taxable cash dividends in relation to capital gains.     

The information content of cash dividend announcements in a unique environment

Due to its distinctive institutional background, Oman offers a valuable opportunity to examine stock price reactions to dividend announcements. In Oman, (1) there are no taxes on dividends and capital gains, (2) there is a high concentration of share ownership, (3) there is low corporate transparency, and (4) firms frequently change their dividends. Our results show that announcements of dividend increases are associated with increased stock prices, while announcements of dividend decreases cause decreases in stock prices. Firms that do not change their dividends experience insignificant negative returns. These results contradict tax-based signaling models, which argue that higher taxes on dividends relative to capital gains are a necessary condition for dividends to be informative.     

Lost in translation: Delayed ex-dividend price adjustments of Hong Kong ADRs

Previous research documents that Hong Kong stocks have a full ex-dividend price adjustment consistent with dividends and capital gains being tax free. We examine ex-dividend price behavior of Hong Kong ADRs to assess the impact of differing tax environments in US and Hong Kong. These ADRs typically go ex-dividend before their underlying stock. They experience significant abnormal returns of 1.16% on their ex-day; the average ex-day price drop is only 30% of the dividend. However, ADR prices drop when the underlying stock goes ex-dividend subsequently. The cumulative ADR price drop is equal to the dividend. Thus, the ADR ex-dividend adjustment resembles that of the underlying stock, consistent with home country tax laws governing ADR price behavior. Neither liquidity nor transaction costs can explain the anomalous delayed ex-dividend adjustment of ADRs.     

Ex-Dividend Day Stock Price Behavior: The Case of the 1986 Tax Reform Act*

This paper analyzes the behavior of stock prices around ex-dividend days after the implementation of the 1986 Tax Reform Act that dramatically reduced the difference between the tax treatment of realized long-term capital gains and dividend income in 1987 and completely eliminated the differential in 1988. We show that this tax change had no effect on the ex-dividend stock price behavior, which is consistent with the hypothesis that long-term individual investors have no significant effect on ex-day stock prices during this time period. The results indicate that the activity of short-term traders and corporate traders dominates the price determination on the ex-day.     

Reduction of Constraints on Arbitrage Trading and Market Efficiency: An Examination of Ex-Day Returns in Hong Kong after Introduction of Electronic Settlement

Previous research documents positive ex-dividend day returns in excess of one percent in the unique institutional setting of Hong Kong, where neither dividends nor capital gains are taxed. Short-term arbitrage trades around the ex-day were hampered by physical settlement procedures. After the recent switch to an electronic settlement system, which enables such trades, ex-day abnormal returns have declined to an insignificant 0.17 percent. This drop is more pronounced for high-yield stocks, which are more likely to attract dividend capture trading. The evidence points to the crucial role of short-term traders in ensuring the pricing efficiency of financial markets.     

Dividend yields and stock returns: Implications of abnormal January returns

This study examines the empirical relation between stock returns and (long-run) dividend yields. The findings show that much of the phenomenon is due to a nonlinear relation between dividend yields and returns in January. Regression coefficients on dividend yields, which some models predict should be non-zero due to differential taxation of dividends and capital gains, exhibit a significant January seasonal, even when controlling for size. This finding is significant since there are no provisions in the after-tax asset pricing models that predict the tax differential is more important in January than in other months.     

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.     

Personal taxes and the time variation of stock returns – evidence from the UK

A potential explanation for the time-series predictability of market returns with dividend yields is the differential tax treatment of capital gains and dividends. This article investigates to what extent the predictability of long-horizon returns can be explained by this tax effect. Assuming that after-tax expected returns are constant, we test the derived relationships between pretax returns and lagged dividend yields with UK data. We also compare the predictability of before-tax long-horizon returns with that of after-tax returns. The results indicate that the tax treatment of dividends does not significantly contribute towards the predictability of stock returns.     

Ex-dividend returns: The Mexican puzzle

We study ex-dividend returns in Mexico, where an imputation system entitles individual investors to a net dividend tax credit. Based on taxation, we expect ex-day abnormal returns to be negative or at most zero in Mexico. However, they are significantly positive. Because ex-day returns are positive even for stocks restricted to Mexican nationals, they are not attributable to foreign stockholders’ tax considerations. None of the market microstructure-based hypothesis in the literature can explain these positive ex-day returns. Ex-day returns in Mexico are a puzzle.     

Time-Series Variation in Dividend Pricing

Ex-dividend day returns vary over time. The ex-day returns of high-yield stocks are persistently positive for some time periods and negative for others; in contrast, ex-day returns of low-yield stocks are always positive and less variable. We are unable to explain the variation with changes in the tax code, but we do find a strong effect for the introduction of negotiated commissions. We find evidence that corporate dividend capturing is affecting ex-day returns and confirm the findings of Gordon and Bradford (1980) that the price of dividends is countercyclical.     

Do Price Discreteness and Transactions Costs Affect Stock Returns? Comparing Ex‐Dividend Pricing before and after Decimalization

By the end of January 2001, all NYSE stocks had converted their price quotations from 1/8s and 1/16s to decimals. This study examines the effect of this change in price quotations on ex‐dividend day activity. We find that abnormal ex‐dividend day returns increase in the 1/16 and decimal pricing eras, relative to the 1/8 era, which is inconsistent with microstructure explanations of ex‐day price movements. We also find that abnormal returns increase in conjunction with a May 1997 reduction in the capital gains tax rate, as they should if relative taxation of dividends and capital gains affects ex‐day pricing.     

The dividend month premium

We find an asset pricing anomaly whereby companies have positive abnormal returns in months when they are predicted to issue a dividend. Abnormal returns in predicted dividend months are high relative to other companies and relative to dividend-paying companies in months without a predicted dividend, making risk-based explanations unlikely. The anomaly is as large as the value premium, but less volatile. The premium is consistent with price pressure from dividend-seeking investors. Measures of liquidity and demand for dividends are associated with larger price increases in the period before the ex-day (when there is no news about the dividend) and larger reversals afterward.     

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.     

Valuation of companies and projects under differential personal taxation

This paper develops formulae for the valuation of companies and projects where there is both differential personal taxation of dividends and interest arising from dividend imputation, and differential taxation of interest and capital gains. The former has been addressed in the literature. This paper represents an extension to recognize both phenomena. It is also shown that valuation errors from ignoring these phenomena are all significant, with the errors from ignoring the interest/capital gains tax differential being at least as great as those from ignoring imputation. Thus, a valuation formula that allows for both phenomena is indicated.     

Effects of tax reform on drop-off ratios and on the ex-dividend and ex-right prices

The main purpose of this paper is to examine the impact of the integrated tax system introduced in Taiwan on the valuation of dividends. Based on Elton and Gruber??s (Rev Econ Stat 52:68?C74, 1970) model, the ratio of ex-day price drop to cash dividend per share (i.e., the drop-off ratio) should reflect the relative taxes on dividends and capital gains. In Taiwan, the suspension of capital gains taxes, the coexistence of taxable and non-taxable stock dividends, and the change in tick sizes allow us to control for the influences of non-tax factors on drop-off ratios. In this paper, we find significant increases in drop-off ratios for both cash dividends and taxable stock dividends after Taiwan??s tax reform (in 1998), while we find no significant changes in drop-off ratios for non-taxable stock dividends. These results provide further evidence to support the argument that tax affects the valuation of firms.     

Trading Behavior and the Unbiasedness of the Market Reaction to Dividend Announcements

This article examines the price formation process during dividend announcement day, using daily closing prices and transactions data. We find that the unconditional positive excess returns, first documented by Kalay and Loewenstein (1985) , are higher for small-firm and low-priced stocks. Price volatility and trading volume also increase during this period. Examination of trade prices relative to the bid-ask spread and volume of trades at bid and asked prices shows that the excess returns cannot be attributed to measurement errors or to spillover effects of tax-related ex-day trading. Rather, the price behavior is related to the absorption of dividend information.     

Shareholder taxation and aggregate dividend payout: Evidence from the tax reform act of 1986

The effect of shareholder taxation on corporate dividend policy is a major controversy in financial economics. The Tax Reform Act of 1986 eliminated the statutory tax disadvantage of dividends versus long-term capital gains for individual shareholders. Using aggregate time series data I find evidence that corporate dividend payout has become more generous in the period after tax reform.     

Dividends and Capital Asset Prices

Tax based dividend models of capital asset pricing assume that dividends are known at the time prices are set. Dividends which are announced and paid in the same month, and dividends which were expected but cancelled in the month constitute surprises which interfere with many empirical tests of the effects of expected dividend yield on returns. This paper avoids these problems by relating returns to forecasts of dividend yield obtained from past data.     

Stock Market Returns and Consumption

This paper employs Swedish data on households' stock holdings to investigate how consumption responds to changes in stock market returns. We instrument the actual capital gains and dividend payments with past portfolio weights. Unrealized capital gains lead to a marginal propensity to consume of 23% for the bottom 50% of the wealth distribution and about 3% for the top 30% of the wealth distribution. Household consumption is significantly more responsive to dividend payouts across all parts of the wealth distribution. Our findings are consistent with households treating capital gains and dividends as separate sources of income.