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.     

HEDGED DIVIDEND CAPTURE AND EX-DAY RETURNS: AN EMPIRICAL UPDATE

We find that the magnitude of abnormal ex-day returns exhibited by US equities diminished in 1987 and 1988, subsequent to the US Tax Reform Act of 1986. We also report the results of a dividend capture strategy, hedged with the sale of stock index futures contracts. Hedging removes more than 50 percent of the risk of dividend capture, and even after transactions costs, can provide returns in excess of buying and holding the market portfolio of equities.     

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.     

Examining the Impact of the 1986 Tax Reform Act on Corporate Dividend Policy: A New Methodology

This article introduces a new methodology to investigate the effects of the 1986 Tax Reform Act (TRA) on corporate dividend policy. The methodology employs a modified version of Rozeff's (1982) model to control for the potential effect of underlying influential variables. The empirical results show there is no widespread reaction to the 1986 TRA passage on the aggregate level of dividends and only modest support for an industry-related dividend effect. We also find that firm size does not play a significant role in dividend policy reaction to the 1986 TRA.     

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.     

THE EFFECT OF THE 1986 TAX REFORM ACT ON EX-DIVIDEND DAY RETURN BEHAVIOR

In this study I examine whether the Tax Reform Act of 1986 has an effect on ex-date stock return behavior. Results indicate that the tax reform has a significant effect on ex-date returns for NASDAQ stocks, but not for NYSE/AMEX stocks. Further analysis suggests that the ex-date returns on NASDAQ stocks are primarily determined by the tax premium. However, the ex-date returns on NYSE/AMEX stocks are more influenced by short-term trading.     

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.     

FURTHER EVIDENCE ON DIVIDEND YIELDS AND THE EX-DIVIDEND DAY STOCK PRICE EFFECT

Ex-dividend day stock price behavior supports a tax clientele effect. This effect is still found after the Tax Reform Act of 1986. Results reflect an effective tax advantage for capital gains taxes payable at realization, versus dividend taxes due quarterly. Evidence also supports short-term trader participation in the ex-day phenomenon when the difference between dividend income and the ex-dividend-day price decrease exceeds transactions costs to trade. Results contradict prior research where a tax clientele effect is not found, but align with this prior research when including a small number of contaminated observations.     

Capital Gains Taxation and Stock Market Activity: Evidence from IPOs

Prior to the Tax Reform Act of 1986 (TRA '86), long-term capital gains were taxed at a lower rate than short-term gains, presenting investors with an opportunity to increase their after-tax return by delaying the sale of appreciated assets until after they qualified for long-term status and selling depreciated assets prior to long-term qualification. Using a sample of Initial Public Offerings, I find that stocks that appreciated prior to long-term qualification exhibit increased volume and decreased returns just after their qualification date, while stocks that depreciated prior to long-term qualification exhibit these effects just prior to their qualification date.     

Time Variation of Ex-Dividend Day Stock Returns and Corporate Dividend Capture: A Reexamination

This paper documents some empirical facts about ex-day abnormal returns to high dividend yield stocks that are potentially subject to corporate dividend capture. We find that average abnormal ex-dividend day returns are uniformly negative in each year after the introduction of negotiated commission rates and that time variation in ex-day returns during the negotiated commission rates era is consistent with corporate tax-based dividend capture. Ex-day returns are more negative when the tax advantage to corporate dividend capture is greatest and more positive when increases in transaction costs and risk reduce incentives to engage in corporate tax-based dividend capture.     

Did the 1986 Tax Reform Act Affect Market Reactions to Stock Splits?: A Test of the Tax-Option Hypothesis

This paper tests the prediction of the tax-option hypothesis that the market impact of stock splits would be reduced by the 1986 Tax Reform Act which eliminated the difference between long- and short-term capital gains tax rates. The results show significant excess returns on stock split announcement and ex-days even after 1986. The announcement and ex-day excess returns are similar in different periods before and after the Act. Further, there is no significant relationship between announcement excess returns and increase in returns volatility following splits. These findings are inconsistent with the tax-option hypothesis.     

Are There Tax Effects in the Relative Pricing of U.S. Government Bonds?

We investigate the impact of the Tax Reform Act of 1986 on the relative pricing of U.S. Treasury bonds. We obtain positive statistically and economically significant estimates for the implicit tax rates of a “representative” investor in the late 1970s and early 1980s. After the 1986 Tax Reform, the point estimates for the tax rate are close to zero. Tests for a regime shift associated with the 1986 Tax Reform support the hypothesis that this event largely eliminated tax effects from the term structure. We discuss both institutional and statutory explanations for this change.     

The smallest firm effect: An international study

Using a carefully screened and filtered international database with a wide coverage across countries and size classes, this paper identifies and documents a post-1980s size effect which is persistent, not picked up by a Fama–French-style SMB, and largely due to the smallest-decile stocks. We test for potential explanations (such as market risk, infrequent trading, financial distress risk, missing book values, momentum, liquidity risk, changing business conditions, January effect, exchange risk, time-varying risk loadings and dividend yield effects), but none can quite explain the international size effect, whether separately or jointly. Fully identifying the missing risk factor is beyond the scope of this paper but we do find that dividend yield shows up as a significant characteristic in the cross-section of risk-adjusted returns, even after controlling for time-varying risk loadings linearly related to dividend yield. When we construct two ad-hoc risk factors that jointly capture the documented size effect, and then correlate these factors with characteristics-based portfolios, we likewise find that especially dividend yield seems to play an important role in the missing risk factor. More generally, this paper revives the debate on the small-firm effect and, we hope, will stimulate further research on a class of stocks that are too interesting to ignore.     

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 MARKET PRICING OF NET OPERATING LOSS CARRYFORWARDS: IMPLICATIONS OF THE TAX MOTIVATIONS OF MERGERS

An empirical analysis of the market pricing of net operating loss carryforwards (NOLs) and the ability for tax considerations to contribute to mergers and the substantial merger premiums often observed by target firms is presented. The restrictive anti-merger tax-transfer provisions of Section 382 of the Tax Reform Act of 1976 (TRA) serve as the legislative vehicle through which performance differentials of NOL and non-NOL firms are measured. The results of the study are consistent with the hypothesis that NOLs are at least partially priced in the absence of a merger, a fact that suggests that tax-motivated mergers may be more myth than reality. Since the anti-merger tax-transfer penalties contained within the Tax Reform Act of 1986 merely represent incremental increases over those of the TRA, the results of the study remain relevant in the current legislative environment.     

Disclosure regulation and information risk

The present paper examines the impact of the Corporations Law Reform Act 1994 on information-based trading in Australian Stock Exchange-listed stocks. Results show that information-based trading is higher in the post-reform period, particularly for lower capitalization stocks. Further analysis shows that this is caused by a fall in turnover and rise in the number of slow trading days. After controlling for these factors, the reform is found to have no impact on information-based trading. Interestingly, the volume of price-sensitive disclosures is found to have no impact on either the level of information-based trading or market spreads.     

LEASING AND THE US 1986 TAX REFORM ACT

The US 1986 Tax Reform Act (TRA) contains several tax provisions affecting many areas of corporate finance including lease financing. One of the more important provisions is the Alternative Minimum Tax (AMT) which determines an alternative in addition to the usual tax computation, and consequently results in a new lessee-lessor tax-asymmetry. To investigate the overall impact on the net advantage of leasing (NAL) of both the AMT and the other relevant provisions of the TRA, a leasing model is developed which incorporates these tax provisions. In the context of this leasing model, the following results are derived. When the AMT provision does not apply, the Tax Reform Act (TRA) reduces substantially the net advantage of leasing (NAL) over buying. In contrast, the effect of the AMT symmetry is positive. As a result, the combined effect of the AMT and the other changes in the TRA on the NAL is negligible for property class of assets of the more common length of time (about ten years), but becomes negative for real-property type of assets.     

The Information Content of Dividend Surprises: Evidence from Germany

This paper reconsiders the issue of share price reactions to dividend announcements. We use the difference between the actual dividend and the analyst consensus forecast as obtained from I/B/E/S as a proxy for the surprise in the dividend announcement. Using data from Germany, we find significant share price reactions after dividend announcements. We use panel methods to analyze the determinants of the share price reactions and find evidence in favour of the cash flow signaling hypothesis and dividend clientele effects. We further find that the price reaction to dividend surprises is related to the ownership structure of the firm. The results do not support the free cash flow hypothesis. An additional result of our analysis is that dividend changes are not an appropriate measure to capture the information content of dividend announcements.     

How Did the 2003 Dividend Tax Cut Affect Stock Prices?

We test the hypothesis that the 2003 dividend tax cut boosted US stock prices and thereby lowered the cost of equity capital. Using an event‐study methodology, we attempt to identify an aggregate stock market effect by comparing the behavior of US common stock prices with that of foreign equities and the equities of real estate investment trusts (REITs). We also examine the relative cross‐sectional response of prices of high‐ and low‐dividend‐paying stocks. We do not find any imprint of the dividend tax cut news on the value of the aggregate US stock market. On the other hand, high‐dividend stocks outperformed low‐dividend stocks by a few percentage points over the event windows, suggesting that the tax cut may have induced asset reallocation within equity portfolios. Finally, the positive abnormal return on nondividend paying US stocks in 2003 does not appear to be tied to tax cut news.