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

Abstract

This paper provides new evidence that tax clienteles exist and that they influence ex-dividend stock price behavior. We test the tax model of ex-day pricing over a continuous sample period spanning all U.S. tax law changes since 1926. Our results indicate that actual ex-dividend price drop ratios (ΔP/D) and market model adjusted returns are related to dividend and capital gains tax rates in the theorized manner. Consistent with the Elton and Gruber (1970) framework, corporate tax were more influential prior to 1962, when dividends were larger, while personal rates are more influential after 1962. We also find that the ex-day price movements of the highest dividend yield stocks within each quarter are driven more by corporate tax rates, while the lowest yield stocks are more influenced by personal rates. Finally, we confirm that ΔP/D is positively related to the dividend yield and show that the strength of this relationship increases as the tax differential widens.

Keywords: Ex-dividend, Taxes, Anomalies, Market efficiency, Dividend clienteles

JEL Classification: G12, G14, G35